UBS predicts the Federal Reserve will implement four consecutive rate cuts, starting in September, amounting to 100 basis points. This forecast is based on inflation staying near target levels and growing labour market risks.
According to UBS, the Fed will utilise upcoming policy meetings to initiate these cuts, allowing room for action due to cooling inflation and lessening job demand. July’s personal consumption expenditures data showed core inflation at 2.9% year-on-year, with headline inflation steady at 2.6%.
Labor Market Dynamics
Price pressures appear contained, with cooling energy prices and stable goods inflation offsetting stubborn services costs. The bank foresees unemployment rates rising above the natural rate by year-end, remaining elevated through 2027.
Recent Fed commentary, including July’s meeting where two dissenting votes favoured a cut, supports this view. Notably, Chair Jerome Powell and other officials have adopted a more dovish tone. Vice Chair Williams and Governor Waller have suggested openness to a September rate cut.
UBS asserts that with inflation nearly at target, and employment concerns growing, the Fed is likely to begin its easing cycle at its next meeting. Rate cuts are expected at four upcoming meetings in late 2025 and early 2026.
With the Federal Reserve’s September 17th meeting just over two weeks away, we see markets already positioning for an easing cycle. The derivatives market, according to the CME FedWatch Tool, is now pricing in an 85% probability of a 25-basis-point rate cut this month. This suggests that trades should be structured to profit from falling interest rates, such as buying options on Secured Overnight Financing Rate (SOFR) futures.
Financial Markets Response
This expectation is putting downward pressure on Treasury yields, with the 10-year note currently hovering around 3.8%. If the Fed follows through with a series of cuts, we could see yields fall further, pushing bond prices higher. This playbook resembles what we observed back in 2019 when a similar Fed pivot led to a significant rally in Treasury futures.
A softer dollar is the most likely outcome of a sustained rate-cutting campaign, making non-US currencies more attractive. The euro, in particular, should strengthen from its current level of around 1.0900 against the dollar. We believe positioning for a move toward 1.1100 in the coming months through long EUR/USD call options is a sound strategy.
For equity markets, this dovish shift provides a significant tailwind, as lower borrowing costs support corporate earnings and investment. The S&P 500, now trading near 5,600, could see further upside momentum if the Fed signals a clear path of easing. This environment makes buying call options or long futures contracts on major stock indices an attractive proposition for the weeks ahead.
Volatility may be the most immediate factor to watch leading up to the September meeting. With the VIX currently at a moderate 16, we anticipate an increase in implied volatility as traders place bets on the Fed’s decision. This could present a short-term opportunity to trade VIX futures or options contracts that profit from this pre-announcement uncertainty.
