The economic landscape is characterised by strong growth over the past year, which continues to persist. Despite this, there is an awareness of raised risks stemming from trade uncertainties.

Tariffs have introduced unpredictability, contributing to potential increases in inflation and possibly dampening growth rates. A cautious approach is adopted to manage these economic challenges.

Economic Expansion And Trade Risks

The message so far lays out a clear backdrop: the economy has been expanding steadily over the last twelve months, showing robust momentum in key sectors. However, that isn’t the full story. Alongside this strength, risks tied to trade friction—especially through the imposition of tariffs—have started to cast a long shadow. These levies push up input costs for companies, which can lead directly to price increases for consumers, feeding into inflation. If not absorbed or bypassed, these rising costs work their way through supply chains and press on profit margins.

From this, it’s evident that expectations for higher inflation may start to build into market pricing, especially in short-dated contracts. Longer-term yield curves too might begin to reflect a changed stance in monetary policy, should central banks see inflation creeping above target ranges. What’s less discussed, though equally vital, is how these tariffs may begin to shave off percentage points from overall expansion, particularly if global trade flows see further restrictions.

For those of us in derivatives markets, the real question is how to position ourselves to capture these shifts early, without being exposed to abrupt turns. With macroeconomic indicators still flashing green, and trade policy being the primary source of concern, directional bets must be balanced with hedges that can benefit from jump risk or volatility skews. Credit spreads may begin to widen in sectors more exposed to global trade, such as manufacturing and consumer durables. Watching how implied volatility behaves across those sectors provides two benefits: early signals of discomfort and an opportunity to extract value from mispricings.

Last week’s PMI readings didn’t underwhelm, which suggests production pipelines remain healthy—for now. However, some parts of the rate curve are already steepening ever so slightly, driven by speculation that current policy might need tightening. Investors and traders alike must resist the temptation to rely on past correlations. Supply disruptions from tariffs could mean inflation and slowing growth appear at the same time, a combination not reflected in many existing hedging strategies.

Monitoring Inflation And Market Positioning

In light of this, keeping an eye on month-over-month inflation data and producer input costs will be essential. Rather than waiting for officials to confirm a slowdown, we lean towards anticipating market moves through break-even inflation rates and implied forwards. There is a clear advantage in strategies that benefit from realised volatility exceeding forecasted levels.

Put spreads in key indices, particularly those heavy in exporters, may now begin to offer a compelling risk-reward. We have also observed a slight uptick in demand for mid-curve optionality, which indicates growing concern over sharp corrections. Some of this nervousness may be speculative, but positioning data shows it’s not just noise.

Powell’s earlier comments have been taken as reaffirming, not deviating markedly from previously telegraphed paths. That hasn’t changed sentiment drastically, but the undertone in markets is shifting subtly, if persistently. Short vol has been profitable of late, but that strategy assumes a level of policy predictability that may not last if trading partners retaliate more than expected.

So then, while growth metrics continue to offer stability, the new variables introduced by policy uncertainty are now the ones driving demand for hedging. Timing entries and exits around economic releases becomes even more important, particularly in front-month expiry cycles. As we weigh risks, it’s no longer sufficient to base assumptions solely on domestic indicators. Cross-border trends, especially in export and import volumes, play just as large a role in shaping forward expectations.

In short, there’s still money to be made. But it’s the second-order effects—like who passes costs on versus who absorbs them—that now hold the key to constructing smarter derivative positions.

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