Russian drone incursions into Poland had little effect on markets, causing only minor increases in the USD. Iran-made Shahed drones reportedly crossed into Poland’s borders, leading to speculation about Russia’s intentions. In response, Poland closed two airports and part of the country went into lockdown, with some politicians describing the event as an “act of war.”
Despite these tensions, the financial markets remained stable. In the U.S., a court ruling retained Lisa Cook as a Fed Governor, affecting the September FOMC meeting vote. The legal clarification suggested that dismissal grounds pertain to conduct in office, not past actions, with the dollar slightly dipping afterwards.
Chinese Economy and Corporate Updates
China’s economy showed signs of deflation, with August CPI at –0.4% y/y and PPI falling by –2.9% y/y. The pace of PPI decline, however, slowed for the first time in months. In corporate updates, Oracle’s shares surged by over 25% following multiple billion-dollar cloud deals.
In the Asia-Pacific markets, various indices showed gains: Japan’s Nikkei 225 rose by 0.65%, Hong Kong’s Hang Seng increased by 1%, the Shanghai Composite was up 0.16%, and Australia’s S&P/ASX 200 grew by 0.25%.
The market’s calm reaction to Russian drones entering Poland presents a clear opportunity. We see this as a significant mispricing of geopolitical risk, with the Cboe Volatility Index (VIX) trading near a low of 14, reminiscent of the complacency seen right before the 2022 invasion of Ukraine caused the index to surge above 35. Buying VIX call options or long-dated puts on European indices like the Euro Stoxx 50 appears to be an inexpensive way to hedge against a sudden escalation.
This heightened tension in Europe could also cause a spike in energy prices, similar to how Brent crude shot from $90 to over $120 per barrel in early 2022. We believe oil and natural gas call options are undervalued given that a direct NATO-Russia confrontation, however unlikely, is now being discussed. These derivative positions offer significant upside if the situation deteriorates over the coming weeks.
Federal Reserve Developments
Regarding the Federal Reserve, the court ruling keeping Governor Cook on the FOMC introduces a dovish tilt just before the next meeting. While Fed Funds futures currently price in a greater than 70% chance of another rate hike, this development adds a layer of uncertainty. We should consider using options straddles on 2-year Treasury note futures to profit from a potential spike in interest rate volatility, regardless of the meeting’s outcome.
China’s slide back into deflation, with consumer prices falling 0.4%, confirms a severe lack of domestic demand. This is bearish for industrial metals and the currencies of countries that export them, so we are looking at buying puts on copper futures and the Australian dollar. With copper already struggling to hold $8,100 per metric ton, further weak data from China could trigger a sharp decline.
Finally, the massive 25% after-hours jump in Oracle’s stock shows that specific tech themes, like enterprise cloud and AI, remain incredibly strong despite the bleak macro picture. Rather than broad index exposure, we are using call option spreads on the Technology Select Sector SPDR Fund (XLK), which is already up 32% year-to-date, to stay invested in this growth story. This allows us to participate in the upside of key tech names while limiting our overall risk.
