In recent days, there has been minimal market change as traders anticipate the US CPI data. The NFP data brought a return to the current market reality, reaffirming two potential rate cuts as the base case scenario.
Impact Of Upcoming CPI Data
The upcoming CPI data may influence market expectations but would require figures deviating from expectations to have an impact. Data aligning with expectations is unlikely to alter the pricing substantially.
By year-end, potential rate cuts are forecasted:
– Fed: 48 basis points, with a 95% chance of no change at the upcoming meeting.
– ECB: 23 basis points, with a 97% chance of no change.
– BoE: 58 basis points, with an 89% likelihood of a rate cut.
– BoC: 21 basis points, with an 87% chance of no change.
– RBA: 56 basis points, with an 80% likelihood of a rate cut.
– RBNZ: 33 basis points, with a 72% chance of a rate cut.
– SNB: 9 basis points, with an 85% chance of no change.
For rate hikes, the BoJ forecasts a 14 basis point increase, with a 99% probability of no change at the upcoming meeting.
The market’s quiet breath-holding is exactly where we see the opportunity. The calm isn’t a sign of stability; it’s the tension before the snap. While the NFP data brought expectations back to a more sensible ground, the upcoming US CPI report is the real crucible. With consensus forecasting headline CPI to cool to a 3.4% annual rate and core inflation to dip to 3.6%, any deviation will trigger an outsized reaction. An in-line print simply kicks the can down the road, but a surprise in either direction unwinds positions fast.
Mispricing In Volatility
We believe the most significant mispricing right now is in volatility. The VIX index, currently slumbering near 13, is not adequately pricing the risk of a market-moving CPI surprise. This reminds us of similar setups in mid-2022, where a placid VIX was shattered by hotter-than-expected inflation data, leading to a cascade in equities. While Fed officials like Williams may strike a balanced tone, we are paying closer attention to the persistent hawkishness from voting members like Kashkari, who recently emphasized that the central bank is not ready to declare victory on inflation. This internal Fed tension is not reflected in such low volatility premiums. Our response, therefore, is to buy volatility. We are looking at short-dated straddles and strangles on major indices heading into the data release. This positions us to profit from the *magnitude* of the move, not the direction, which is precisely where we see the market’s complacency.
Looking abroad, the priced-in 58 basis points of cuts from Bailey seems heroic. The latest data showed UK wage growth remains stubbornly high at 6.0%, a key metric the Bank of England is watching. This sticky figure suggests their path to cutting is far more complicated than the market implies, making derivatives that bet against such an aggressive cutting cycle look attractive. Similarly, the 23 bps priced for the ECB may understate their caution. With the latest Eurozone core inflation proving sticky at 2.7%, well above their target, policymakers there have little incentive to rush.
The true divergence play remains with the Bank of Japan. While only 14 bps of hikes are priced in, the yen continues to weaken, with the dollar recently breaching the ¥156 level. This persistent weakness, combined with Japan’s own core inflation hitting 2.2% in March, increases the probability of a more substantial policy shift sooner than anticipated. The risk-reward for trades positioned for a hawkish surprise from the BoJ is becoming increasingly compelling.
