Insights 
VT 
BofA Securities maintains its forecast that the Federal Reserve will not lower interest rates in 2025. This is despite market speculation for a rate reduction as early as September due to weaker July jobs data and significant downward revisions.
According to CME’s FedWatch Tool, there is now over a 90% likelihood of a rate cut at the Fed’s meeting in mid-September. However, BofA analysts expect rates to stay between 4.25% and 4.5%, suggesting cuts would only occur if the labour market genuinely deteriorates.
Market Confusion Over Economic Signals
They caution that markets may be misreading the situation, confusing recession risks with stagflation. Despite decreased worker demand, a reduction of 802,000 in the foreign-born labour force since April has maintained labour market stability.
BofA points out that wage growth and total labour income continue to be robust. With inflation still above the Fed’s 2% target, any rate cut could be premature without signs of an economic downturn. Fed Chair Powell is expected to accept weaker job growth as long as unemployment remains stable, prioritising inflation control over employment concerns.
We are seeing derivative markets now pricing in over a 90% chance of a rate cut at the Fed’s September meeting. This reaction is a direct result of the weaker-than-expected July jobs report from last Friday, which posted a gain of only 110,000 jobs against expectations of 180,000. Significant downward revisions to May and June data have amplified this sentiment.
Despite this, we believe the Federal Reserve will hold rates steady through the rest of 2025. The crucial factor is that inflation remains sticky, with the latest Core PCE reading for June coming in at 3.1%, still significantly above the 2% target. This situation looks more like stagflation than a simple recession, complicating the Fed’s path.
Opportunities in Volatility
Traders should look past the headline job number and focus on labor market tightness. The recent drop in the foreign-born labor force has kept the supply of workers constrained, preventing a significant rise in unemployment which has held steady near 4.1% for much of the year. With Average Hourly Earnings still growing at a 3.9% annual pace, underlying wage pressures persist.
We have seen this divergence before, particularly when we look back at 2023. Throughout that year, markets repeatedly priced in Fed rate cuts that failed to materialize as officials prioritized fighting inflation over pre-empting a slowdown. Today’s situation feels similar, with the Fed likely willing to tolerate weaker growth to ensure inflation is defeated.
This disconnect between market pricing and potential Fed policy creates an opportunity in volatility. Options on interest rate futures, such as those tied to the Secured Overnight Financing Rate (SOFR), are likely underpricing the risk of a hawkish surprise at the September 17th meeting. Traders should consider strategies that benefit from a rise in implied volatility ahead of that event.
For those with a higher conviction in the “no cut” scenario, calendar spreads in SOFR futures could be attractive. This involves selling the near-term contracts (like September or December 2025) that have aggressively priced in cuts, while buying longer-dated contracts. Such a position would profit if the Fed holds firm, causing the front end of the yield curve to reprice higher.
