Really All You Need To Know

CPI “loomed large,” someone said Tuesday, I’m sure. That’s not an actual quote from anyone but absent something meaningful to say, it’s standard operating procedure to resort to boilerplate copy that references the nearest top-tier data.

Ahead of this week’s update on US inflation, journalists had the luxury of being sandwiched between NFP (last week) and a CPI report which will either support the “overshoot” narrative or else bolster the Fed’s “transitory” talking points. It’s easy to craft a few paragraphs of perfunctory market color in this environment even as it’s somewhat vexing for analysts who are frozen in “wait and see” purgatory.

As for traders, “everybody [is] selling TY strangles / pitching 3m10Y downside… contributing to this overall three-month range trade stasis in UST yields,” Nomura’s Charlie McElligott said Tuesday.

He noted that while it might seem counterintuitive that folks would be keen to play for a continuation of the sideways drift in rates considering not just the ostensibly binary character of May CPI, but this week’s Treasury supply and the ECB meeting as well, the fact that market participants are willing to discount the potentially combustible mix suggests they don’t think it’s likely to combust. Charlie explains that,

What this likely tells us is that 1) the Fed’s “transitory” inflation language and “might be time to talk about talking-about Tapering” messaging insistence, in conjunction with 2) the “Goldilocks 2.0” US data (Surveys- and Inflation- “positive,” but versus Labor- and Industrial- “negative”), is currently “holding-court” and driving a fatigue in theta-bleeding options trades playing for higher interest rates in the near-term–i.e. the seeming liquidation of a short-dated ED$ downside expression with the sale of large Aug midcurve Put Fly yesterday, in some ways corroborating a growing view that “taper timing” is being reset further out now (MNI reporting that “Jackson Hole Too Early For Powell To Signal Taper” as per former Fed researchers interviewed)

For the layperson, that passage may make for a challenging parse, but for serious market participants, it’s an incredibly insightful and incisive assessment.

This does all fit together, by the way. For example, BMO’s Ian Lyngen (who embodies the term “incisive”) wrote that “gradual gains [for Treasurys] are made all the more compelling in the context of this week’s known events – i.e. supply and Thursday’s inflation data.”

Elaborating, Lyngen added that although the “series of June 3s/10s/30s hasn’t historically been a market-mover in the traditional sense, with an eye on the bullish seasonal patterns in Treasurys it is worth an acknowledgement that supply and CPI represent event risks which, if sufficiently within range of expectations, will pass without much lingering price action and clear the way for a drift lower in US rates.”

Pair that with the commentary from McElligott and you can get a better handle on the range trade and “vol smash” (to quote Charlie) in rates.

Panning out a bit (where that means sorting through some commentary that’s a bit less granular), Morgan Stanley’s Mike Wilson made some of the same points (or, at the least, managed to underscore a similar message) in less technical terms.

“Last week’s jobs report… could be spun in several different ways to support either side of the argument [but] it does provide the Fed with ammunition to remain fully dovish if they so choose,” he wrote, on the way to wondering if, just as May payrolls represented a return to robust jobs growth (it was shy of consensus but still managed to make April’s huge downside surprise look like an anomaly), May CPI might similarly “mean revert,” perhaps printing cooler than expected.

“The bottom line is that we just don’t have a strong edge here,” Wilson remarked, adding that with the macro likely “to remain noisy and highly unpredictable,” the data is “unlikely to elicit any meaningful response from the Fed in the near term.”

And that’s really all you need to know.