The Fed’s policy is leaning towards holding rates steady, with a focus on managing inflation. Despite the current rate nearing neutral, inflation is still viewed as too high, which supports a cautious approach. Tariffs are seen as having a muted impact on inflation, reinforcing the stance against cutting rates.
Fed’s Internal Divide
Fed President Jeff Schmid, who is more hawkish, supports a patient approach when considering changes to the Fed’s policy rate. There is recognition that the full effect of tariffs on prices is uncertain. Views may adjust if signs of weakened demand growth appear, but the current preference is not to ease policy unless necessary.
Within the Fed, there is a division over the future direction of rate changes. Bowman and Waller favour cuts, while Musalem and Schmid prefer to hold. Barkin remains neutral. Despite the market indicating a 90% chance for a cut, Fed Chair Powell’s upcoming speech at the Jackson Hole Economic Symposium may provide further clarity on the Fed’s stance.
We are seeing a significant split between market expectations and recent Federal Reserve commentary. While current pricing on the CME FedWatch Tool shows a 90% probability of a rate cut next month, voting member Jeff Schmid is signaling a preference to hold. This divergence between market pricing and a voting member’s hawkish tone sets the stage for potential volatility.
Schmid’s patient stance is backed by recent inflation data, which remains stubbornly above the 2% target. The latest Consumer Price Index (CPI) reading for July 2025 came in at 3.3%, showing that price pressures have not cooled enough to justify an immediate policy shift. This makes the argument for holding rates more credible than the market currently believes.
Market Reaction Strategies
This uncertainty suggests that options premiums on interest rate futures and major indices may be underpriced. We believe traders should consider strategies that benefit from a rise in volatility, as the market could see a significant repricing after Chair Powell speaks. The CBOE Volatility Index (VIX) has been hovering near 14, a level that has historically preceded sharp moves during periods of policy uncertainty.
We should remember how Jerome Powell has used the Jackson Hole symposium in the past to reset market expectations. Back in August 2022, his short and direct speech dashed hopes for a policy pivot, causing a sharp market downturn. A similar hawkish surprise on August 23rd of this year could unwind the market’s dovish positioning.
If the hawkish view prevails and the Fed signals a hold, we could see a rapid increase in short-term bond yields. Traders might consider buying puts on Treasury note futures or using bearish spreads on equity indices like the S&P 500. The market’s near-certainty for a cut presents an asymmetric risk-reward profile for those positioned for a hawkish surprise.
