July’s US employment report led markets to pare back expectations of a Federal Reserve rate rise in September, adding pressure to the Dollar and pushing 2-year yields 8bp lower. Non-farm payrolls fell 23k, compounded by 103k of downward revisions to the prior two months, which left the three-month average at 20,000. The unemployment rate dipped to 4.1% from 4.2%, while the participation rate declined, and average hourly earnings growth eased to 3.2% year-on-year from 3.5%. Fed funds futures now imply 10bp of a possible 25bp move for 16 September.
Attention now turns to another jobs report, two CPI releases and the Federal Reserve’s Jackson Hole Symposium before the September FOMC meeting. Markets will also assess next week’s July CPI, with expectations for headline prices to rise 0.1% month-on-month and core prices to increase 0.2%. A potential deal to reopen the Strait of Hormuz is framed as a channel to lower petrol prices and support disinflation through year-end, keeping policy on hold well into 2027.
Market Reaction and Opportunities in Rates and FX
We are seeing a significant shift in the rates market following the surprisingly weak July jobs data, which showed payrolls contracting by 23,000. With the US 2-year Treasury yield already dropping by 8 basis points to hover around the 3.90% mark, the argument for further Fed rate hikes has crumbled. Derivative traders should prepare for a period of declining yields by going long on short-term interest rate futures, such as Secured Overnight Financing Rate (SOFR) contracts.
The softening of the US dollar index, which recently slipped toward the 102.20 level, presents a clear opportunity for currency option strategies. We suggest buying EUR/USD call options to capture the upside as yield differentials narrow in favor of the Eurozone. Given that Fed funds futures are now pricing in less than a 10% chance of a full 25-basis-point hike in September, holding long-dollar positions is highly risky right now.
Trading Strategies Ahead of Key Data and Fed Pause
We must also prepare for the upcoming July CPI release next week, which we expect to show a mild 0.1% month-on-month headline increase. This disinflationary trend, coupled with potential geopolitical relief in energy markets, will likely depress yields further. Traders should consider buying call options on 10-year Treasury note futures to profit from this impending bond rally.
Because we anticipate a prolonged Fed pause extending well into 2027, the yield curve is poised to steepen. We recommend entering bull-steepener positions by going long on 2-year Treasury futures while shorting 10-year futures. This setup historically performs well when the market realizes that interest rates have officially peaked and will remain steady for a long time.
