Recent data shows that GDP growth has slowed, primarily due to decreased consumer spending. However, business investment has increased during this period.
Disinflation in service sectors persists, with job gains not meeting the breakeven rate, indicating a softening of labor demand. The balance of risks has tilted, with a rise in risks to employment.
Temporary Tariffs
There is an expectation that current tariffs may be temporary, but there remains a possibility they could have lingering effects. Efforts are focused on ensuring one-time changes do not become persistent issues.
A step towards a neutral stance has been taken, maintaining the ability to react swiftly to changes. Meanwhile, initial market movements were reversed, with the US dollar returning to previous levels.
The Fed is signaling its rate-hiking cycle is likely over, shifting our focus from *if* they will hike to *when* they will cut. The conflicting data, with slowing consumers but accelerating business investment, creates a confusing picture for the market. This uncertainty means we should expect market volatility to rise in the coming weeks.
We see the odds of a rate cut by the first quarter of 2026 increasing, especially after the August 2025 jobs report showed a gain of only 85,000 jobs, well below the breakeven level. Derivative traders should be watching SOFR and Fed Funds futures to position for this dovish pivot. The market is now pricing in at least two cuts by the middle of next year.
Stock Market Implications
For stock indices, this is a double-edged sword, as the prospect of easier money is balanced by the slowing economy that is causing it. This brings to mind the fourth quarter of 2018, when a Fed pause failed to stop an equity market slide due to growth fears. Given the added uncertainty from potential tariffs, buying VIX calls or using index option strangles could be a sensible hedge against a sharp move.
The U.S. dollar’s quick rebound after its initial drop suggests the market isn’t fully convinced the Fed will cut before other central banks. However, if we see more weak data like the recent 0.3% fall in August retail sales, the dollar’s downtrend should resume. We could use options to position for a lower dollar, particularly against currencies where inflation remains a bigger problem.
With core services inflation now down to a 3.2% annual rate, the risk of inflation re-accelerating seems to be fading. This environment of falling inflation and the prospect of lower rates is historically very supportive for gold. We should consider buying calls on gold futures or ETFs to profit from this setup.
