Muted Market Anticipates Subtle Cues from Upcoming Inflation Data

As traders eagerly anticipate the upcoming US inflation data, there is a sense of calm pervading the financial market. According to Citigroup Inc., the options market predicts that the S&P 500 Index could potentially move by 0.9% in either direction following the release of the consumer price index (CPI) figures on May 23. This indicates that traders are carefully monitoring the data for indications regarding the amount of interest rate cuts that the Federal Reserve may implement this year. Interestingly, this calmness comes following a period of subdued volatility, as evidenced by the VIX Index measuring S&P volatility currently sitting near its lowest point of the year. Moreover, volatility for VIX options, used to safeguard against significant market drops, is at its lowest level in nine years. Since the Fed’s decision on May 1, wagers in the Treasury market have been leaning towards more substantial rate cuts. This trend is particularly noticeable after recent reports revealed that employers scaled back their hiring during April, but analysts believe that this development could signal a softening of the labour market following a promising start to the year. Overall, the fall in volatility and decreasing put premiums have made broad-based stock market hedging more appealing, with some VIX call spread purchasing spotted recently. Furthermore, the decrease in the S&P 500 skew, which has now reached a ten-year low, has lowered the cost of collar strategies that combine selling calls and buying puts. In terms of the bond market, covering of shorts and the emergence of fresh long positions have been observed since the Fed’s policy statement and April’s employment report. Following the Fed Chair Jerome Powell’s comments that removed the prospect of a further rate hike as the most probable course of action, short covering was widespread. Recently, fresh options indicate that tail-risk hedging has shifted to a more forceful path of rate cuts, with some SOFR option positions even centred around the possibility of a rate cut as soon as July. A significant risk reversal trade worth up to $15 million was spotted last week in SOFR options maturing on May 24, targeting a decrease in the 10-year Treasury bond yield to 4.25%, with potential losses of approximately $15 million incurred if yields climb to around 4.7%.