(Bloomberg) - From JPMorgan Chase & Co. to Citigroup Inc., Wall Street’s most prominent trading desks are warning that investors should gear up for a potential break in the calm that’s come over the market.
The options market is betting that the S&P 500 Index will move 1% in either direction after Wednesday’s report on consumer prices, based on the price of that day’s at-the-money straddles, according to Andrew Tyler, head of US market Intelligence at JPMorgan Chase’s trading desk. For Stuart Kaiser, Citigroup’s head of US equity trading strategy, the broader market is bracing for a move around CPI that’s in line with expectations on May 23 — the day after Nvidia Corp. delivers its latest earnings results.
The CPI report will be closely watched by traders for signals as to how much the Federal Reserve may cut interest rates this year. That said, which part of CPI traders will focus on and how they will place bets in various scenarios are where the differences lie over how much the equities benchmark may swing, per Tyler.
“The key risk is a hotter CPI print,” Tyler and his team wrote in a note to clients on Monday. For instance, if month-over-month core CPI tops 0.4%, that would likely spur a selloff across all risk assets, with the S&P 500 falling between 1.75% to 2.5% as investors find shelter in commodity plays, Tyler says.
But if core CPI comes in between 0.3% and 0.35% from the prior month — near JPMorgan and consensus forecasts — the S&P 500’s outcome ranges from a 0.5% loss to a 1% gain, depending on whether rent inflation remains elevated, Tyler added. Any outcome where the core month-over-month declines sequentially will be “read as a positive by the market,” especially if the figure comes in below 0.2%, which may even revive bets for a June rate cut and send the S&P 500 higher by 2% to 2.5%, he added.
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 — last week fell to the lowest in nine years.
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, according to Citigroup.
“Inflation has been the bigger event for traders the past two years and still is,” Citigroup’s Kaiser 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 and Monday.
“The rise in interest rates that has pushed up SPX forwards increases call premiums relative to puts,” said 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.”
By Jessica Menton
