The Federal Reserve is divided on whether to hold interest rates steady or pursue cuts. Only officials Waller and Bowman dissent in favour of a cut.
A divide exists over tariffs, with some arguing for clarity before policy adjustments, while others disagree on waiting for full clarity. The majority assess inflation risks as higher than those for employment.
Dove Versus Hawk Debate
Doves, including Waller and Bowman, advocate ignoring tariff-induced price rises and pushing for rate cuts. Hawks focus on firmer price pressures, especially in services, maintaining that the Fed’s current stance helps manage tariff effects.
Kansas City Federal Reserve’s Schmid criticised the method of calculating “inflation ex-tariffs,” deeming it irrelevant. The minutes indicate an increasing divide within the Fed, foreshadowing a contentious debate at the upcoming September meeting.
Since the July meeting, the debate has intensified. Doves argue for ignoring tariff-related price rises, citing weaker labour data to support early cuts. In contrast, Hawks observe increased price pressures, particularly in services, and praise the Fed’s consistent stance in containing tariff impacts. Schmid reinforced the division by dismissing the practice of excluding tariffs from inflation calculations.
The growing division within the Fed suggests we should prepare for heightened market volatility in the weeks leading up to the September meeting. This uncertainty between holding rates steady and cutting them creates opportunities in options markets. The main debate centers on whether to ignore tariff-related inflation, a split that makes the Fed’s next move difficult to predict.
Market Implications
We saw the July 2025 jobs report, released earlier this month, come in weaker than expected, with payrolls adding just 150,000 and the unemployment rate ticking up to 4.1%. This data supports the doves who are pushing for a September rate cut to protect employment. On the other hand, the latest CPI reading showed core services inflation remains sticky at 4.3%, giving the hawks a reason to hold firm.
This clear divergence means implied volatility on equity and rate derivatives is likely undervalued. We have already seen the VIX index creep up from 14 to 19 over the past month, reflecting this growing policy uncertainty. Traders should consider buying straddles or strangles on major indices ahead of the next inflation report and the September Fed decision, as these strategies profit from a large price move in either direction.
The interest rate futures market is now pricing in a roughly 40% probability of a 25-basis-point cut in September, a significant increase from just 15% a month ago. This shows the dovish argument is gaining traction, but it is far from a certainty. This pricing suggests that a decision to hold rates firm could cause a sharp upward move in short-term yields.
We can look back to the policy debates of 2018, when uncertainty around trade policy and Fed rate hikes created significant market swings. During that period, the Fed’s communication became critical, and any perceived shift in tone caused sharp repricing events. We are likely entering a similar environment where Fed speeches will be scrutinized intensely for any hint of a leaning.
