Insights 
VT 
The Dow Jones Industrial Average (DJIA) reached record highs on Friday, surpassing 47,300. This rise followed lower than expected US Consumer Price Index (CPI) inflation figures, boosting optimism about potential interest rate cuts by the Federal Reserve.
Headline CPI inflation was 3.0% YoY in September, slightly below the anticipated 3.1%. This spurred market movements, with expectations of two quarter-point rate cuts by year-end. Despite inflation not aligning with the Fed’s 2% target, the expectation of rate adjustments remains high.
Probability Of Rate Cuts
The CME’s FedWatch Tool indicates over 95% probability for rate cuts in October and December. The timeline for the first 2026 rate cut has shifted to March. September’s PMI results exceeded market expectations, with the Services component rising to 55.2 compared to the expected 53.5.
Despite business confidence rising, consumer sentiment fell, with the University of Michigan Consumer Sentiment Index dropping to 53.6. UoM Consumer 5-year Inflation Expectations increased to 3.9% from 3.7%. Inflation remains a concern, driven by supply chain issues. The Fed continues to take measures ensuring price stability and employment, focusing on these challenges after the pandemic.
With the Dow Jones hitting a record high above 47,300, the market’s direction is overwhelmingly bullish. The primary driver is the widespread expectation of two Federal Reserve interest rate cuts before the end of the year, a scenario now given a 95% probability by the futures market. We believe this environment favors strategies that capitalize on continued upward momentum in equities.
Given this strong positive sentiment, traders should consider call options on major indices like the SPY and DIA, particularly those with December 2025 expiries to align with the expected rate cuts. This bullishness is reminiscent of the market pivot we saw in late 2023, where the S&P 500 rallied nearly 14% in the final two months of the year on similar hopes of Fed easing. The current low volatility, with the VIX index recently trading near 13, makes buying these call options relatively inexpensive.
Divergence In Market And Consumer Sentiment
However, we must also acknowledge the clear disconnect between euphoric markets and cautious consumers. The decline in the University of Michigan Consumer Sentiment Index alongside a rise in consumer inflation expectations to 3.9% is a warning sign. This suggests that while investors are celebrating, the average household is still struggling with the cost of living, which could eventually impact corporate earnings.
This divergence makes a case for protective strategies that are currently cheap to implement. Buying out-of-the-money put options on indices can serve as a low-cost insurance policy against any unexpected hawkishness from the Fed or a sudden downturn in economic data. With volatility so low, hedging against a potential market pullback is more affordable than it has been for most of the year.
