Mary Daly of the Federal Reserve expressed reduced confidence in her economic outlook following the release of a hotter-than-expected Personal Consumption Expenditures (PCE) report. Despite her earlier remarks about the possibility of rate cuts occurring twice this year, the recent data has led to a reassessment of her predictions.
Daly’s shift in tone after the latest core PCE deflator figures reflects an adjustment that will resonate broadly through rate-linked instruments. The monthly and annualised readings came in firmer than consensus, indicating that inflation is not cooling at the pace policymakers had projected. This puts earlier expectations about monetary easing under pressure, especially from those who anticipated a more supportive environment in the second half of the year.
Confidence In Disinflation Weakens
The hesitation displayed underscores that confidence in disinflation has weakened. Service prices remain sticky, and wages continue to expand in a way that complicates any clean narrative toward policy relaxation. For us, this recalibration implies that any near-term pivot in short-end rates is not only delayed but may be repriced more aggressively if the trend in price pressures persists.
Traders holding exposure in front-end volatility should be cautious with duration here. The repricing of implied paths may become more forceful and disorderly depending on the messaging from future minutes or job figures. There’s little tolerance right now for upside surprises.
Daly’s comments were not isolated remarks. When placed against recent communications by other policymakers, including those who typically lean dovish, there’s now a shared reluctance to confirm when rate relief becomes viable. We’ve seen the implied probabilities for cuts shift on the back of this, particularly with September and December contracts showing wider dispersion across desks.
Upside Protection Gains Traction
Short vol trades dependent on timing the policy turn are now more prone to being whipsawed. Demand for upside protection in interest rate options has already picked up, and historically when that happens this early in a quarter, it tends not to reverse quickly. Positioning should not be static—carry will not compensate enough unless one is precisely directional.
Moreover, keep an eye on forward swaps curves. A flattening bias has returned, as the market begins to question whether the soft landing narrative might give way to something more drawn out. The risk, plainly, is that inflation stays where it is for longer, and that growth doesn’t accommodate the sort of disinflationary slack previously assumed.
Instead of relying on fixed timelines, it is more productive at this stage to assign greater weight to each data point as it lands. Employment metrics, in particular, will now carry more consequence than usual. Any upward revisions in wage growth will feed directly into expectations and could trigger fast hedging flows.
We cannot ignore the probability that Powell and his colleagues prioritise evidence over early moves this cycle. As long as price stability goals remain undershot, flexibility on the timing of any adjustment means we must react rather than speculate too early.
With option volatility trending higher and realised moves back in favour, conditions suggest positioning should remain tactical. Profiles built around pinpointing a rate trough too early might face roll-forward risks. Range trading at the front of the curve appears safer until there’s more clarity.
As it stands, even the reliable pattern of front-running policy hints is less dependable. It’s better to widen the lens and observe cumulative developments, not just single releases. And given the tone of Daly’s revision, assume the margin for error has narrowed.
