ST Note - US Oct CPI preview ST Note - US Oct CPI preview ST Note - US Oct CPI preview

ST Note - US Oct CPI preview

Junvum Kim

Sales Trader

Summary:  When Sep CPI came lower than prior but higher than expected, S&P 500 index futures (ESZ2) had immediate reaction selling off ~3% and USDJPY - best carry trade among G10 yielding 5% - also rallied 100 pips so these two are expected to be most obvious ones to trade and show instant price action in terms of sensitivity to the data.

First headline squawk highlighted in red that I saw this morning on my Bloomberg terminal was “BITCOIN DROPS BELOW $16,000…”. Last time Bitcoin (BTCUSD) dipped below $16,000 was 2 years ago and now it has fallen 77% from all time high $69,000 that was traded 1 year ago. Also to put this price action into perspective, Bitcoin/gold ratio has declined to just over 9 times compared to 35 times last year. When I checked on, FTX - on the verge of potential bankruptcy - was the fourth biggest cryptocurrency spot exchange based on traffic, liquidity & volume, hence the risk-off sentiment has well and truly arrived as some of the notable crypto related stocks got hammered – COIN -10%, MSTR -20%, GLXY -16% while safehaven US dollar bid up broadly heading into October US CPI release tonight at 9:30pm. However we are yet to see significant systematic risk as VIX sitting at 26 with futures term structure of contango and high yield junk bond ETF (HYG) has not crashed trading 2.2% above recent low $70.40 as well as credit spread is also off 100bps below from the recent high 600bps.

The current macro backdrop continues to focus and assess on the relative impact on inflation from rising real yield (10 year at 1.7%) or aggressiveness of interest rates hikes while Fed’s QT has been shrinking its balance sheet by about 3.2% from $8.9t to $8.6 in the last seven months. Even though last week’s unemployment rate looks to have bottomed from 3.5% to 3.7%, two of the mostly watched yield curves – 3m10y and 2y10y - still remain inverted at 9bps & 48bps respectively and we are not seeing substantial steepening happening yet therefore the futures implied terminal rate ~5% in 2Q next year may still have further rooms to move higher despite recent FOMC meeting’s down-shift signal and Powell’s cumulative tightening of 375bps, the most in one year since 1980. 

The previous headline Sep CPI numbers 8.2% YoY showed major drivers were food, medical and shelter contributing nearly 1% each while energy and cars cooled. This time, energy may have gone up a bit and services would remain as a key area to watch as it has not stopped rising every month since Aug last year. The most recent PCE figures for Sep was 6.2% that is not only above Fed’s projection of central tendency 5.3%-5.7% but also far from its longer run target of 2%. After all, we have not seen sub 8% headline CPI since February number this year and actual result was less than estimate only once for July but given the estimate for tonight’s figures is anticipated at 7.9%, meeting this estimate may be sufficient for the equity market to find some relief rally.

On 13 October, when Sep CPI came lower than prior but higher than expected, S&P 500 index futures (ESZ2) had immediate reaction selling off ~3% and USDJPY - best carry trade among G10 yielding 5% - also rallied 100 pips so these two are expected to be most obvious ones to trade and show instant price action in terms of sensitivity to the data. S&P 500 had a decent rebound last month digesting earnings as 456 companies have now reported with earnings surprise of 3% that is lowest in the last two years post Covid. S&P 500 forward earnings per share (EPS) estimated at 226 makes the PE ratio 16.6 times or 6% yield based on last night’s close 3,748 but again there-are-reasonable-alternatives (TARA) as 2 year treasury is at 4.6% and IG corporate bond ETF (LQD) giving nearly 6% with relatively lower implied volatility compared to SPY (13 vs 24).

Lastly USDJPY is trading near a key level 145 that previously acted as resistance in September then turned into support level in the last two weeks. Correlation between USDJPY and US 2 year treasury yield remains high so the pair should be able to at least consolidate assuming 145 holds while long out-of-the-money call options could also work given 1 month implied volatility has fallen from 17 to 11 in recent weeks and 2 vol lower than realised volatility. Alternatively by taking more neutral to bullish view with possible Japan intervention, bull put spread (credit) could be considered using the same level 145 as the lower strike to long put and sell higher strike – say 148.50 that is half way between the recent high 152 and 145 – giving net premium of about 200 pips for one month expiry.

Descending S&P 500 forward PE while USDJPY and US 2 year yield rising with high correlation


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