Monetary Policy Signals
Neel Kashkari from the Federal Reserve foresees two more quarter-point rate cuts this year. He supported the recent rate cut, viewing it as a response to potential sharp unemployment increases. Kashkari believes the neutral rate may have risen to 3.1%.
The Fed’s policy may not be as tight as once thought. Kashkari suggests that if the labour market weakens, rates can be cut more quickly. However, if the labour market remains strong or inflation rises, the policy rate should pause. He is open to raising the policy rate should economic conditions change.
While it’s unlikely inflation will rise much above 3% due to tariffs, Kashkari views rate hikes as a future possibility. Although Kashkari won’t vote this year, he will next year, maintaining his long-standing hawkish stance.
With the Federal Reserve having just cut rates this week, the signal for two more quarter-point cuts this year sets a clear path for short-term interest rate derivatives. We should be looking at December 2025 and January 2026 SOFR futures to price in a policy rate that could be half a point lower by year-end. This view is reinforced by the latest August jobs report, which saw unemployment tick up to 4.2%, giving the Fed cover to act pre-emptively.
The biggest risk to this dovish path is the labor market, making upcoming Non-Farm Payrolls reports critical trading events. The warning that policy could be paused if the labor market proves resilient means we should expect heightened volatility around these releases. We could consider using options straddles on equity indices or bond ETFs to play the sharp moves that are likely to follow the next employment figures.
Watching Economic Indicators
We must also watch inflation data, as the latest Core PCE reading of 2.8% is still stubbornly above the 2% target. A surprise increase in the next CPI report could quickly erase expectations for one or both of the remaining cuts. Remembering the inflation shock of 2022, any sign of re-acceleration would cause a significant repricing in the bond market.
For equity derivatives, this guidance creates a complex picture where bad economic news is good for the market. We can position for further upside in rate-sensitive sectors like technology and real estate using call spreads. However, the explicit concern about a “sharp increase in unemployment” means holding some downside protection, such as puts on the broader S&P 500, is a prudent hedge.
Longer-term, the idea that the neutral rate has risen to around 3.1% is a major shift from the thinking we saw in the last decade. It suggests that even when this cutting cycle ends, rates will not return to the lows we saw after 2008. This should put a floor on how low long-term yields can go, impacting pricing for options with expirations deep into 2026.
