The session has been calm, with focus on the upcoming US CPI release. The resilient labour market data suggest that even with softer figures, the Federal Reserve is not expected to cut rates in July. Market expectations may shift towards rate cuts from September, which could impact the US dollar and support risk assets.
Higher-than-expected CPI figures could prompt strong market reactions. Although one data point does not define a trend, the market might adjust inflation risk premiums. The US dollar may strengthen, with potential corrections in asset prices and some ‘profit taking’ in risk trades. Consensus anticipates a Core Year/Year figure of 2.9-3.0% and a Core Month/Month measure of 0.2-0.3%. Deviations from these could result in significant market reactions.
Focus on Us and Canadian Data
The Canadian CPI release is expected, but market attention remains on the US data. The German ZEW index showed improvement, reflecting optimism due to easing trade war concerns and supportive fiscal measures. US-EU trade talks continue positively, with no immediate concerns. Remarks from US Treasury Secretary Bessent indicated no intention from Trump to replace Powell, suggesting the CPI figure might carry less weight initially as trends hold greater importance.
The wait is over, and the market got the deviation it was looking for. The Core M/M print came in at 0.2%, undershooting the consensus and providing the initial fuel for the soft-landing narrative. This prompted the exact reaction we anticipated for a soft number: the dollar weakened and risk assets surged. The S&P 500, for instance, immediately rallied to fresh all-time highs post-release. However, the celebration was cut short by the Fed’s own messaging just hours later.
This is where the real opportunity for traders now lies. While the inflation data was a clear green light, the Fed’s updated dot plot flashed a hawkish yellow, projecting just one rate cut for 2024. Powell then spent his press conference reinforcing that they need more than one data point to build confidence. Bessent’s hint about a higher CPI didn’t pan out, but his focus on the “trend” is precisely what the Fed is now clinging to as its justification for patience. This creates a fascinating and tradable divergence.
Opportunities for Derivative Traders
For derivative traders, this setup screams “buy cheap volatility.” We are looking at a market that is pricing in immaculate disinflation while the central bank is actively pushing back. The VIX has been languishing near the 12-13 level, which historically represents extreme complacency. We believe buying protection here is not just prudent, it’s opportunistic. We are not calling for a crash, but the cost of insuring against a summer correction via August or September puts on the SPX or NDX is now exceptionally low. The market has priced in the good news; it is unprepared for any bumps in the road ahead, whether from the resilient labor market data or a stubborn inflation print next month.
In the rates space, the divergence is even starker. As of this week, Fed Funds futures are still pricing in a roughly 60% chance of a rate cut by the September meeting, a direct contradiction of the Fed’s own median projection. This tug-of-war between market optimism and Fed caution suggests bond market volatility is likely to awaken from its slumber. The MOVE index, a measure of Treasury market volatility, has fallen significantly from its highs. We see value in structures like straddles on Treasury ETFs (like TLT), which would profit from a significant move in either direction as this pricing discrepancy inevitably resolves itself.
On the currency front, the dollar’s path is now muddied. The soft inflation data argues for weakness, but a hawkish Fed provides a strong backstop. This is no longer a simple directional bet. We would advocate for using options to define risk, perhaps through collars on major pairs like the EUR/USD. This allows for participation in a move while capping potential losses if the market suddenly decides to listen to what Powell is actually saying, rather than what it hopes he means.
