The session has been calm, focusing on the upcoming US Consumer Price Index (CPI) release. Strong labor market data suggests that even if the CPI figures are lower, the Federal Reserve is unlikely to cut rates in July. However, market expectations may shift towards potential rate cuts starting in September, which could influence the US dollar and benefit risk assets. If CPI figures are higher than expected, it may lead to significant market movements. While one number doesn’t set a trend, it could change how the market views inflation risks. A stronger US dollar might lead to corrections in asset prices, with traders locking in profits on riskier investments. The consensus expects a Core Year-over-Year figure of 2.9-3.0% and a Core Month-over-Month measure of 0.2-0.3%. Any notable differences from these estimates could cause major market reactions.

Focus on US and Canadian Data

Although the Canadian CPI release is anticipated, most market attention is on the US data. The German ZEW index has shown improvement, signaling optimism due to easing trade war worries and supportive fiscal measures. US-EU trade talks are progressing well, with no immediate issues. US Treasury Secretary Bessent indicated that Trump does not intend to replace Powell, suggesting that the CPI figure may initially carry less weight, as longer-term trends are more critical. The market has finally received the anticipated deviation. The Core Month-over-Month print was 0.2%, below expectations, fueling the soft-landing narrative. This led to the expected response: the dollar weakened and risk assets soared. For example, the S&P 500 quickly rose to new all-time highs after the release. However, the celebration was short-lived due to messaging from the Fed only hours later. This is where the real opportunity for traders lies. While the inflation data was clearly positive, the Fed’s updated dot plot leaned hawkish, indicating only one rate cut for 2024. Powell reinforced the need for more than one data point to build confidence. Bessent’s suggestion of a higher CPI didn’t materialize, but his emphasis on the “trend” is what the Fed is focusing on to justify its patience. This creates an interesting and tradable divergence.

Opportunities for Derivative Traders

For derivative traders, this situation signals a chance to “buy cheap volatility.” The market is pricing in ideal disinflation while the central bank pushes back. The VIX has stagnated around the 12-13 range, which usually indicates extreme calmness. We believe that buying protection here is not only sensible but a smart opportunity. We’re not predicting a crash, but the cost to insure against a summer correction using August or September puts on the SPX or NDX is currently very low. The market has factored in good news but isn’t ready for any surprises, whether from resilient labor market data or a stubborn inflation report next month. In the rates market, the divergence is even clearer. This week, Fed Funds futures are still pricing in about a 60% chance for a rate cut by September, directly conflicting with the Fed’s median projection. This tug-of-war between market optimism and Fed caution suggests bond market volatility could awaken. The MOVE index, which measures Treasury market volatility, has dropped significantly. We see value in structures like straddles on Treasury ETFs (like TLT), which would benefit from a large movement in either direction as this pricing gap narrows. On the currency side, the dollar’s direction is now uncertain. The soft inflation data suggests weakness, but a hawkish Fed offers support. This situation is no longer a straightforward bet. We recommend using options to define risk, perhaps through collars on major pairs like EUR/USD. This approach allows for participation in potential price movements while limiting losses if the market starts to react to Powell’s actual statements rather than what traders hope he means. Create your live VT Markets account and start trading now.

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