(Bloomberg) — Traders are eyeing this week’s US inflation data for a potential break in the calm that’s come over the market.
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The options market is betting that the S&P 500 Index will move 0.9% in either direction after Wednesday’s report on consumer prices, based on the price of that day’s at-the-money straddles, according to Citigroup Inc. The report will be closely watched by traders for signals as to how much the Federal Reserve may cut interest rates this year.
A big swing around the CPI report comes as volatility across markets has been tamped down. The VIX Index measuring S&P volatility is near the year’s low, while volatility on VIX options — used to hedge against a big market selloff — is the lowest in nine years. At the same time, since the Fed decision on May 1, bets in the Treasury market have been tilting toward more aggressive rate cuts.
The broader market is bracing for a big move around CPI that’s in line with expectations on May 23 — the day after Nvidia Corp. delivers its latest earnings results. Those implied moves are larger swings than what’s expected following the government’s next jobs report, due on June 7, even after employers scaled back hiring in April, suggesting cooling in the labor market after a strong start to the year.
“Inflation has been the bigger event for traders the past two years and still is,” Stuart Kaiser, Citigroup Inc.’s head of US equity trading strategy said over the phone. “Despite a recent payrolls miss, any prints that show more than 150,000 jobs were created in a given month, investors will largely be comfortable with that because it still reflects a strong labor market. If job growth were to come in below that, the market will start to shift its focus toward hiring growth over inflation.”
Overall, the slide in volatility and lower premiums for puts has made broader stock market hedging more attractive, and some VIX call spread buying was seen last week.
“The rise in interest rates that has pushed up SPX forwards increases call premiums relative to puts,” Tanvir Sandhu, Chief Global Derivatives Strategist at Bloomberg Intelligence. “This has eased the entry for collar strategies that sell calls and buy puts. The decline in the SPX skew, which is close to the low of the last 10-year range, has also reduced the cost of this strategy.”
Treasury market positioning leading into the inflation report appears to have been somewhat neutralized, given covering of shorts and initiation of new long positions seen since the Fed’s policy announcement and the April jobs report.
In the immediate aftermath of the central bank decision, notable short covering of SOFR futures was seen as Fed Chair Jerome Powell appeared to remove the tail-risk of a hike being the next policy move. Longs then started to build. Recent options have suggested that tail-risk hedging has shifted to a more aggressive path of rate cuts, with some positioning in SOFR options even centered around the potential for a rate cut as early as July.
One large risk-reversal trade late last week in options expiring May 24 targeted a drop in the 10-year Treasury note’s yield to 4.25%, while risking losses of up to $15 million an increase to around 4.7%.
Read more: High-Risk Options Bet on Bond Rally at Risk of Losing Millions
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