The market anticipates 25 basis point rate cuts at each of the next three FOMC meetings, but the focus is on the September 17 meeting where there is about a 10% chance of a 50 basis point cut. Such a cut would require an unexpectedly low Consumer Price Index figure, with the relevant report due soon.
The President recently commented on the Producer Price Index, reiterating his call for rate cuts. This follows his similar statements last month when the PPI increased by 0.9% month-on-month.
The Challenge Of Appointment
Despite criticising the current Chair, the President was responsible for appointing him. The task of finding a replacement may prove challenging.
The political noise is getting louder, but for us, the focus is squarely on the CPI data tomorrow and the Fed meeting on September 17. The market has already priced in a 25 basis point cut as the most likely outcome. This means the real trading opportunity is in positioning for a surprise, not the expected result.
That small 10% chance of a 50 basis point cut is where the lottery tickets are, and it’s a direct bet on a surprisingly low inflation number. We have seen the VIX creep up from a low of 13 last month to near 18, suggesting traders are buying protection ahead of the data. Buying cheap, out-of-the-money call options on bond ETFs or even Fed Funds futures is a direct way to play for a dovish surprise from the Fed.
Given the last CPI reading in August was a bit sticky at 3.3%, uncertainty is running high, making volatility a tradable asset itself. Options pricing, particularly for contracts expiring right after the September 17 meeting, shows an elevated premium for this event risk. We are looking at straddles or VIX call options to profit from a large market swing, regardless of the direction.
Preparing For The Fed’s Decision
We must also be prepared for Powell to push back against the pressure, especially if CPI doesn’t show significant cooling. We remember the market’s sharp downturn in late 2018 when the Fed continued its path despite similar political commentary. A small position in put options on major indices serves as a valuable hedge if the Fed decides to reassert its independence and disappoints the market.
