Daily Brief For May 10, 2023

CPI rising by a below-forecast 4.9%.


Our levels have been working. For instance, as shown below, yesterday’s Daily Brief levels were key response areas for the Micro E-mini S&P 500 Index (FUTURE: /MES).

Graphic: Retrieved from TradingView.

Some of the levels overlap centers of options activity; falling volatility coincides with increased sensitivity among those options, lending to reversion and responsiveness.

“This continues to suggest that our theoretical framework of ‘options dominance’ is indeed the driver. In 2017 when the XIV (inverted VIX ETF) was king of the hill, that 44bps high-low range would have been the 47%ile,” reports Tier1Alpha. “If you think these markets are boring, try 2017. Our suspicion is that similar forces are at work, just concentrated in 0dte options. The 2017 bear market in vol came to an end with Volmaggedon. The cycle will end this time as well, but the catalyst remains to be seen.”

Graphic: Retrieved from Michael Green of Simplify Asset Management.

Consequently, per SpotGamma, “there is little room for error.”

From an options positioning perspective, for volatility to reprice lower and boost the market, “we need a change in [the] volatility regime,” SpotGamma previously added. The likelihood of that happening is low since many expect the Federal Reserve (Fed) to stick to its message of higher rates for longer, notwithstanding the consumer price index rising by a below-forecast 4.9%, the first sub-5% reading in two years. Overall prices remain hot, and the job market remains robust. Policymakers need more than one month of data to be confident that prices are on a sustained downward path, Bloomberg reports.

Graphic: Retrieved from Bloomberg.

“Inflation is higher than the Fed’s mandate and not on a path to get to that mandate soon. The CPI report is one data point, and most measures show elevated inflation. Areas that had been disinflationary are reverting. And the stickiest parts of inflation remain elevated.”

Graphic: Retrieved from Bob Elliott of Unlimited Funds.

So, support for a pause or hold is the more likely scenario.

“When pauses have occurred against the backdrop of tight labor markets, the Fed has rarely eased in the subsequent six months — the most common outcome has been an on-hold Fed,” explained Praveen Korapaty of Goldman Sachs Group Inc (NYSE: GS). “In contrast, periods with material deterioration in the labor market have more reliably resulted in easing. At least during this period, the inflation backdrop at the time of the pause does not appear to have had a material influence on policy actions.”

Graphic: Retrieved from Goldman Sachs Group Inc (NYSE: GS) via Bloomberg. “As this chart from Goldman shows, when the employment is tight (which it plainly is at present), pauses tend to become extended. It’s only when employment is seriously deteriorating (on the right side of the chart) that the Fed pivots swiftly.”

Moreover, heading into price updates this morning, the expectation was for a smaller move in the S&P 500. However, with volatility very low, we’ve maintained that selling options blindly is dangerous. When you least expect significant movement, it often happens; just before the opening, the market has moved over 1.0%.

Graphic: Retrieved from Pat Hennessy of IPS Strategic Captial Management. “Welp, it was fun while it lasted. SPX straddle only pricing 83bps for tomorrow ahead of CPI, lowest on record since dailies were listed in May 2022.”

Check out our detailed trade structuring report for more on how to better manage a portfolio in this enviornment.

Graphic: Retrieved from Bloomberg. “The case for concerted easing rests fundamentally on the yield curve. Long-dated bonds have been paying a lower rate than shorter securities for the best part of a year, and this is a well-known recession indicator,” John Authers says. “It’s also a serious headache for banks, who traditionally borrow at low short rates (via deposits), lend at a higher rate, and make their profit from the difference. Banks, we know, are in trouble. If claims of a ‘crisis’ are a tad overblown, the deposit flight created for them by the inverted curve will contribute to the recessionary environment.” A way for the curve to return to its usual shape is for the Fed to cut rates, but the consensus among pros is that won’t happen for some more time.


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