The Dow Jones Industrial Average fell on Tuesday, dropping below the previous week’s close but maintaining near-term consolidation levels. The US Consumer Price Index (CPI) showed inflation remains above Federal Reserve targets, affecting hopes for a rate cut in the summer.
Inflation rose at the end of the second quarter, with annualised headline CPI increasing to 2.7% year-on-year in June. Despite forecasts, inflationary trends have diminished the likelihood of an early rate cut from the Federal Reserve.
Fed’s July Meeting Forecasts
The CME’s FedWatch Tool indicates a fully priced-in rate hold at the Fed’s July meeting, with only 44% odds for a hold in September. Despite persistent inflation, there are 80% odds for at least a quarter-point rate cut by October 2025.
Nvidia is back in the spotlight after the announcement about permission to resume sales in China was made, though changes in regulations could impact this positively or negatively. Nvidia’s market cap has reached $4 trillion, a significant milestone, with its stock up by 1,500% since its low in October 2022.
The Dow Jones declined by over 0.85%, shedding nearly 400 points amidst a choppy phase despite tech gains. The index remains bullish, yet underperforming its tech-biased counterparts, still below previous all-time highs.
Market Volatility Expectations
We see the recent inflation data as a primary driver for a cautious stance in the coming weeks. With consumer prices remaining elevated, the timeline for a rate reduction from the central bank is likely pushed further out. This environment suggests we should prepare for continued uncertainty and choppy price action in the broader market.
Given the divided odds for a policy change in September, we believe market volatility is poised to increase from its current lows. The CBOE Volatility Index, or VIX, has been trading around 13, which is significantly below its long-term average of about 20. This makes buying options relatively cheap, presenting an opportunity to use straddles on broad market indexes to profit from a significant price move, regardless of direction.
Regarding the prominent chipmaker that has seen its valuation surge, we see two-sided risk from the regulatory environment governing its international business. We would consider using call spreads to participate in further upside while limiting our premium outlay and defining our maximum risk. This approach allows us to stay engaged with the stock’s powerful momentum while acknowledging the potential for sharp pullbacks.
The underperformance of the industrial average compared to its tech-biased counterparts highlights a divergence that we find actionable. A pairs trade, going long a tech index tracker while shorting a tracker of the laggard index, is a strategy to capitalize on this performance gap. For those with long portfolios, buying protective puts on an index like the SPY offers a direct hedge against a potential downturn sparked by stubbornly high interest rates.
