Federal Reserve Vice President Phillip Jefferson indicated that both employment and inflation are currently posing risks to the Fed’s dual mandate. The labour market is displaying fresh weaknesses, coupled with mounting inflation pressures.

A notable decline in net immigration has played a major role in preventing a sharp rise in unemployment. Current trends suggest a softening job market, which could experience additional stress if not supported.

Adjustments to Policy

Recent adjustments have aimed at bringing policy closer to a neutral stance while managing a balanced approach. Tariffs are contributing to inflation in certain goods, although disinflation is anticipated to resume next year.

The removal of “average” from the Fed’s framework was deemed necessary due to its communication challenges. The strategy of running inflation above target to compensate for past deviations has proven impractical.

Efforts are ongoing to understand the potential impact of artificial intelligence on productivity. The Fed remains confident it will achieve its 2% inflation target, with long-term inflation expectations anchored around this level. Tariff adjustments have shown a moderate response, though the inflationary impact might take longer than expected. The Fed’s role includes ensuring tariff adjustments do not lead to persistent inflation.

The Federal Reserve is clearly in a difficult position, caught between a weaker job market and persistent inflation. The September 2025 jobs report confirmed this softening trend, with non-farm payrolls adding only 110,000 jobs and the unemployment rate ticking up to 4.2%. This weakness is happening while the latest Core CPI data from August remains stuck at a stubborn 3.1%, making the Fed’s next move very uncertain.

Market Strategies

We believe this environment is ideal for long volatility strategies, as the Fed’s delicate balancing act could lead to sharp market swings in the coming weeks. Buying straddles or strangles on major indices ahead of the late October Fed meeting could be a prudent way to position for a surprise in either direction. The VIX, which has been hovering around 19, seems to be underpricing the risk of either a hawkish inflation-focused statement or a more significant dovish pivot if employment data worsens.

In the interest rates market, there appears to be a disconnect that we can trade. The Fed funds futures market is currently pricing in about a 60% chance of another 25-basis-point rate cut by December, yet officials continue to stress that their job on inflation is not done. This suggests that paying fixed on short-term interest rate swaps or using options on SOFR futures could offer value if the Fed is forced to hold rates higher for longer than the market expects.

This policy ambiguity is also putting downward pressure on the US dollar, as the path for future interest rates is less clear than it was earlier in the year. We saw a similar dynamic back in late 2023, when the market began aggressively pricing in rate cuts well before the Fed was ready to signal a pivot. Consequently, call options on gold and other currencies against the dollar seem increasingly attractive as a hedge against both policy error and sticky inflation.

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