Markets head into the new week still stressed after one of the more turbulent stretches since last year’s regional banking crisis.
On the surface anyway, US equities came away from the early-August vol shock mostly unscathed. The S&P ended unchanged last week, as did the broadest measure of global equities.
But the the intraday swings witnessed on the way to what, from the August 5 lows to the August 9 highs, was a ~515bps rebound in futures, were indicative of “extreme pockets of stress” among traders and market makers, as Nomura’s Charlie McElligott put it.
The simple figure above gives you a sense of how the outcome distribution expanded over the last two weeks.
Remember: When the outcome distribution expands, so does realized vol, and that engenders de-allocation from target vol strats. As discussed here, the magnitude of the realized vol reset likely means the vol control cohort won’t be buying in size for a while yet. Realized vol needs to compress again, and for that you need to see spot equities settle back into a more pedestrian range.
That’s the equities setup for CPI week in the US. Consensus is looking for 0.2% from the MoM core reading. As a reminder, we’re coming off the best US CPI release of the post-pandemic era. The Fed has seen three benign reports in a row. The last two releases were outright favorable.
As the figure above shows, an as-expected print from the July release would mark an acceleration from June’s 0.065% (unrounded) pace, but it’d still be consistent with the Fed’s messaging (sans Michelle Bowman, anyway) and would leave a 25bps September rate cut as a lock.
The risk, obviously, is an upside surprise. That’d be most unwelcome given the growth scare backdrop. “[T]he average estimate is +0.19% and forecasts are in a narrow range [so] the market is particularly vulnerable to an upside surprise on the inflation front,” BMO’s Ian Lyngen and Vail Hartman wrote. “While [not] our base case by any means, it strikes us that with 40bps of rate cuts priced in for the September 18 FOMC meeting, the risk of a ‘high’ 0.2% or ‘low’ 0.3% is being unduly discounted at the moment.”
Although rate-cut pricing receded from the August 5 extremes, markets are still looking for more than 100bps of Fed easing by year-end.
Just about the last thing that pricing needs is a shock upside inflation print.
I suppose this goes without saying, but: The juxtaposition between a (hypothetical) inflation overshoot and recent growth concerns would be poor indeed, which is to say it’d be a stagflation optic. Nerves are still frayed from last week, dealers and market makers are still sorting through PnL issues from the VIX call stop-in and it’s anyway the middle of August — with everything that entails for market depth and liquidity.
God willing we won’t see a CPI overshoot. Assuming a consensus read, pricing for the September FOMC meeting may drift back towards 25bps versus the ~even odds of a half-point move priced as of August 9. Even a marginal upside surprise won’t derail a quarter-point cut next month. It’d take a serious overshoot (think: 0.4% MoM on core) to call into question a move in September.
Also on deck this week in the US: PPI (which, as per the usual reminder, is more relevant for PCE prices than CPI), August homebuilder sentiment, housing starts and, critically, retail sales. Nominal spending across the world’s largest economy probably rose 0.4% last month, economists reckon, even as the control group’s seen moderating in line with the broader slowdown narrative.
Elsewhere, China publishes retail sales data as well. Recall that spending rose a mere 2% YoY in June, a disastrous result that underscored the country’s ongoing struggle to revive domestic demand. Economists expect a pick up from the upcoming release — sort of. July’s print, due Thursday alongside an update on industrial production and fixed investment, is seen at 2.6%.
In the UK, wage growth data and an inflation update from ONS will be viewed in the context of the BoE’s August rate cut, the first of the cycle.
