Is Inflation Cooling Enough for the Fed?

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1:24And now to the top analysis of today's markets.

1:35Is inflation cooling enough for the Fed? Welcome to Real Vision Daily Briefing. It's Wednesday, April 12, 2023. I'm Ash Bennington, joined today by Imran Laka, founder of Options Insight. Imran, welcome back. Thanks for having me. Good to see you again, Ash. Oh, man, it's always a pleasure to have you on Real Vision Daily Briefing. I enjoy these conversations. You bring a level of depth and analysis that I always find intriguing and challenging to follow because you have so much insight from the options perspective that I don't ordinarily consider. Imran, obviously, big day-to-day CPI printout.

2:06Big picture, what are your thoughts? What's happening? So, yeah, I mean, all eyes were on CPI. You know, the options market was only pricing about 1 % break-even on the straddle, which basically means that's the expected move. And, you know, if you had compared that to CPI numbers previous months, you know, going back into the end of last year, it was double that, right? So clearly the market is thinking or was thinking that it was going to be less market moving now as the shift has now gone towards the banking and the credit concerns and the jobs market. So as we can see, we have chopped around quite a bit, but net net we didn't move too much on the CPI number.

2:46But it has come in with deceleration. So we've seen core services, less shelter, which is like the main thing everyone's looking at now, did decelerate. So potentially gives the Fed cover to pause. That's what the market was already looking for. We look at the rates market on the back of the banking crisis. So the market's kind of got what it wanted to some extent. Why is it selling off, though? Because everyone was already kind of expecting this. This hasn't necessarily surprised anyone to the dovish side. People might have thought, oh, look, it's a dovish FMC minutes. It's a dovish number on this DPI.

3:24We should get a rally. But you could argue the rally was already pricing that in. So this is just in line with what we expected. I don't know if we can take a look at the chart. This is a chart from the Wall Street Journal that shows precisely what you were just talking about there, Imran. This is the chart looking at CPI on an annualized basis for both core and headline. Let me just go through this for folks who didn't happen to see that print. Month over month, we're up 0.1 % actual on a prior of 0.4, as you say, deceleration. On a year-over-year basis, 6 % prior. Current, 5%. This, of course, is for the month of March versus February being the prior month.

4:04Interestingly enough, as you can see on that chart, obviously more volatility in the headline number than in the X food and energy. That's the core number. While we're seeing deceleration, less deceleration there than we saw in the headline number, 0.5 % previous. Consensus was 0.4, came in actual 0.4. At the top of the consensus range, though, consensus range being 0.3 to 0.4, pretty narrow range, pretty narrow tolerance. But coming in at the top of that on core X food and energy. Yeah, I mean, but, you know, people look at three-month seasonally adjusted numbers and things like that, all different types of measures whatever you want to look at but ultimately power kind of signaled that tighter bank lending was going to do some of the work of further hikes right and and that's kind of being confirmed in terms of what we're seeing in the fomc minutes a lot of people some people considered not hiking in the last meeting um so you know that this kind of it's not really a pivot yet but the pause that the market was looking for seems to have been confirmed um the question now is the three odd cuts that we're expecting by the end of the year, do they materialize?

5:17And I think we're going to find out a lot more information in the coming FOMC meetings and as more data comes through to see how that discrepancy between market pricing and the dot plot resolves itself. Well, let's talk a little bit about that because it's an important point. We had the chair of the New York Fed, John Williams, coming out yesterday saying that he believed that there was probably one more rate hike in store. Give us your sense of what that means, what the context is on that. Obviously, there's an expectation of cuts going forward, but it seems as though we may have one more hike left in us in terms of the Fed's view, at least if the comments yesterday from Mr.

5:55Williams are to be taken seriously and literally. Yeah, I mean, there's a bit of inertia, right, with these institutions, right? They don't want to they don't want to look like they're just going to turn the titanic on every every next data print right so so they want you to they want to guide market expectations a bit more slowly they can't just suddenly reverse engines but what they what they are saying is okay we think we're done after one more and like we say that it's the tighter bank lending that's going to do the work of further hikes right so so i think i think it makes sense them signaling it this way but but the question as well is are the three cuts really three cuts that the market's pricing or is it more some sort of probability of a load more cuts because we're going to go into a big old credit crisis right so rather than rather than thinking the market's really pricing three cuts to the end of the year maybe what the market's really pricing is 20 chance of them just taking rates all the way back down right because they have to so so that's another way of interpreting this kind of discrepancy in the rates market pricing to the modal outcome may well be that they just hold rates at five percent but if we get the bad tail outcome on the banking crisis and you know the commercial commercial real estate market we have all those problems kick off in the coming quarters then are they going to be forced to really take rates down to like a one to one percent two percent whatever it is that that's what the market has to kind of get its head around over coming months i would say.

7:28Yeah, that's very well said. Let me throw this out here just to make the argument because we had Thomas Barkin, this is president of the Richmond Fed, out today, 1045 on Bloomberg, making comments that seem hawkish. Let me just read this to you and get your opinion. Quote, I certainly think we are past peak on inflation, but we still have a ways to go. There's still more to do, I think, to get core inflation back down to where we'd like it to be. No mystery there. When you look at that chart that we showed earlier with CPI, they use PC, personal consumption expenditures. We're looking at consumer price index.

8:01But bottom line, still way above 2%. The president barkin saying still more work to do. Yeah, I mean, the truth is with all these Fed speakers, I think what you need to look at is the market reaction, right? And the rates market has kind of spoken today, right? Yields haven't moved that much. But if anything, those short-end yields, they came back down, right? So no one really believes that they're going to be able to be particularly hawkish, it seems. Hey, walk us through that. You talk about the market reaction to it. Tell us what you're looking at, the specific metrics that you're looking at in terms of seeing these rates move.

8:44Because it's incredibly important, I think, for people to understand what you see on your dashboard. And explain that to folks, what it means and why it's significant. yeah so you just want to look on days like this you kind of want to see what the two years doing so two-year yield you want to see what that's doing because that's kind of anchoring the front end really right but what the 30 year does doesn't really tell us a whole lot about rates expectations right so really looking at sofa futures and you're looking at two-year rates security financing is what you're talking about yeah but if you if you just look at the two-year yield, that gives you a good feel for what the front end is doing, right, just to keep it simple.

9:22So we're looking at right now, let's just walk through this because we've got some information here. So 3.966, under 4 % on the two-year US Treasury yield right now. Obviously, you see that very steep decline today. What does that mean? What is the significance of that in terms of how you understand it? Well, it's just basically saying that there was, you know, nothing hawkish in the reaction right so the two-year yield reprice from above five percent to you know as low as 3.6 it's had a little bounce off there but it's but it's back below four percent again so it's just kind of saying that whatever we've heard from the fomc minutes and what we're seeing in the inflation data is confirming the repricing in the front end of the curve So even though the jobs data arguably was a little bit more robust on Friday, it seems like the rates market is anchoring more to the idea that, yes, we are seeing the disinflation and the FOMC minutes confirm that the Fed really do are responding to what they're seeing in the banking system.

10:34And, you know, they're saying things like the banking system is resilient and all that. But ultimately, the tighter lending standards are going to feed through and do the work that the hikes up to potentially when terminal rates were closer to 6%, the work of those last few hikes will be done by the tighter lending standards. That's the message that the market is giving. We're going to take a quick break and be right back with more of the day's top analysis on the Real Vision daily briefing. Have you ever wanted to trade Bitcoin but haven't dared try? With Plus 500 Futures, you can trade crypto without the hassle of opening a wallet.

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12:05So for people who are relatively new to this, how do you explain to them what seems to be a palpable disconnect between what Fed bank presidents are saying? I've got the quote in front of me here. This is from yesterday. Federal Reserve Bank of New York President John Williams saying that he thinks it's a, quote, a reasonable starting place to think about one more rate hike this year. And yet you see markets, you see actual market participants pricing precisely the opposite, as you point out, the decrease in yield at the front of the curve. How do you explain that disconnect? Because, you know, a lot of the time the market tells the Fed what to do.

12:40The Fed are looking at lagging data a lot of the time, right? So the market's always forward-looking, whereas the Fed are somewhat backward-looking. you know they can they can respond to what the market is telling them and they can make comments that are a bit more forward looking but in terms of the data that they're working off it seems like they're much more backward looking right so i think that's what you would put it down to uh so talking about looking forward let's take a look at some of your indicators i know we were talking about the vix uh offline here just before we started uh walk us through that chart so we've been we've been calling for the vicks to go lower um for the last month or so um you know after we had the obviously the big blow up up to 30 on the banking crisis and we were fading that move uh we were buying puts put calendars things like that to play a move back down that worked out pretty well uh we have started taking we started taking those off of the last week um just before easter we thought a lot was getting priced in so now you can see this vicks chart i mean vicks is a mean reverting animal but it's back down to the lower end of the range that support band between 17 and 18 has kind of held for quite some time so we think you know you'd literally need the market to just sit still and realize a very low level of vol for like two three months for the vix to really break down significantly below that support zone that's not really what we anticipate um given there's quite a lot of uncertainty out there with regards to the banking with regards to policy So we do think it does make sense now from a mean reversion perspective to look to the upside again.

14:20Rates vol has stayed relatively more elevated than equity vol. So again, rates vol being the big driver of cross asset volatility since last year, again, gives us some comfort that the VIX will probably be dragged back up again at some point. So just looking at that chart, we can see, right, not a bad time to cover shorts and think about getting long. We then look at the next set of charts, right? So then this just, this is a few snapshots of what the VIX term structure looks like, right? So this is the VIX curve. So just like you have an interest rate curve, you also have the VIX curve, right?

14:56So you have different contracts that you can trade on the VIX. So the current curve is that yellow one, which is quite steep and upward sloping. You know, a month ago in the midst of the banking crisis, it was that green one, which is more like a flat line at around 25. about six months ago say October last year again markets were on the back foot and vol was quite a bit higher in the mid-20s and but it was an upward sloping curve again and then a year ago the blue line it was even higher and it was inverted or back related where you had vol in the kind of mid-30s moving down to around 30 in the back end right so this should give you a sense of kind of the range of where the VIX can actually go and the kind of shape that that curve can take yeah So right now, it just shows you that we're in quite a low vol regime in terms of the shape of that VIX curve.

15:46And it's very steep right now. And then last chart. So another way we measure that steepness is we can compare two contracts on the VIX. We can compare the spread between two VIX contracts. So if I look at, say, the second VIX contract, which right now would be the May contract versus the fourth one, which would be the July contract. and we look at the steepness of that curve and see where that steepness typically lives, where it trades, well, you can see that going back over a year or about a year, sorry, that it's quite, it's at the top of the range, which is basically, it's pretty much as steep as it gets in terms of two month, four month contract, right?

16:28So that says to me that the two month contract is quite low. It's quite cheap relative to the four month contract. So there's not much to me. It's basically there's not much downside in that May contract because already priced in a lot of bearishness on volatility, basically. Right. And because I see volatility turning back up because we've got earnings kicking off, we've got FOMC in early May and fair amount of uncertainty around the FOMC. Right. And the signaling that we might get from that meeting and the June meeting, I don't think Bowles is going to keep getting crushed. Right. So I'm using these metrics and these metrics all pointing to me that May VIX is looking quite good value now, basically.

17:13If I ask you to connect the dots a little bit between what we were just talking about on the rates front with the VIX is the idea here, generally speaking, that as you see accommodative monetary policy, you see essentially volatility compression. In other words, you see the VIX decline because you see more accommodative monetary policy. yeah so you know typically when we've had an accommodated fed risk assets have rallied and volatility goes down right so but i would say that the move we've seen in the vix yes it's been helped by the fact that risk assets have done well but it's been more of a seasonal thing going into easter right so you you get periods like christmas like easter where if the market doesn't have a really good reason to move a lot vol just goes down right that's a seasonal effect so now that we're passing out that seasonal effect you've got another seasonal effect which is your selling may and go away effect right which might cause vol to tick back up again right and also the fact that the market has priced in a bit of a pause from the fed and three cuts between now and the end of the year you could argue that now the risk reward is for more hawkish rhetoric or data to come to surprise markets and then that would take risk assets lower and that would take um vix higher again basically so that's the idea the idea is we already had a bit of a dovish repricing in the rates market we've had risk assets prove to be quite resilient we know it's been led by those mega cap mega cap tech stocks so under the hood the breadth of the market isn't great right so it's just a question of whether those those big tech stocks are going to start to come back down again some people are looking at apple is a pretty decent short at the moment just from a technical perspective.

18:55So if those big cap techs do come down, the rest of the stocks are not trading well anyway, right? So there is a potential tactical window for VIX to go up. Now, I'm not looking for a move above 30 or anything silly like that. Just the mean reversion move that takes the VIX from 18, 19 back to 24 to 26 is pretty doable, I would say. And as you said, something of a floor right now for the VIX at 18. Listen, while we're talking about Fed pivots, I wanted to take a look at something because it's very germane to this conversation. A clip of a deep dive, the most important macro indicator with Andreas Steno Larsson on Essential out today.

19:34Let's take a look at that. I'm fairly certain that something will break in the system. We currently see banking turmoil. I think the next shoe to drop could be real estate, in particular commercial real estate. And that leaves me with the impression that the recession is just around the corner and that prices will come down sharply into the summer. That is of course of relevance to the central bank reaction function of the Federal Reserve. I think we are within weeks of some kind of pivot. We've already seen the first moves in that direction from the Federal Reserve via various emergency measures.

20:21But the next move is more permanent move towards easier monetary policy again. And that will alter quite a few of the trends we've seen over the past couple of quarters. I think it's very good news for interest rate sensitive assets. Good news for crypto, good news for tech, good news for the Teslas of the stock market. And it's good news for bonds again. So you just heard from a dovish Andreas Stenos-Larsen. Let me just read out a couple of my key takeaways on this. So fairly certain that something is going to break in the system, and that leaves him with the impression that recession is around the corner.

21:05We're in for some kind of a pivot in the next few weeks, he says. But the next move is going to be toward a more permanent, easier money policy. And then he goes on to say, I think it's very good news for interest rates, sensitive assets, good news for crypto, good news for tech, and good news for the Teslas of the stock market. Imran, any thoughts? Yeah, I mean, the old playbook is if rates are going down, stocks are going up, right? That's what we've been used to but you know looking back further in history and looking back at the 70s and 80s some analysis done by bank of america they say you should sell the last hike not buy the last hike right so it kind of depends what regime you're in so i don't know the answer right i'm not smart enough to know the answer i'll let andreas and and mike hartnett of bank of america fight it out between themselves but there's two schools of thought here that it's not a given that just because it's the last hike, we should party again and buy all the tech stocks and crypto again.

22:10So I don't know. I think the jury's out still. People want to party. That's always the risk. There's always that bias. Hey, listen, we were talking a little bit off camera about the mechanism by which you gain exposure to the VIX. A couple of different options there. Talk us through that. Explain the pros and cons and why you do what you do to get VIX exposure. Yes. So it's pretty tricky to buy VIX, right? Because you can't buy VIX spot. So you have to buy VIX futures. The problem with buying VIX futures is they experience what we call a roll down because they trade a premium to the actual VIX spot.

22:45So if you hold them for too long, through the passage of time, they just roll down against you and you lose money if you don't get a nice big VIX spike. So you're kind of fighting against that time element, right? Now, one way to mitigate that and this is what i teach my subscribers and and i you know the work that i do is you can structure option trades that give you upside exposure to the vix but again those of you trade options know that you have a time decay element you have to pay so if you buy calls on vix they're typically very expensive as well so what you have to do is you have to buy like cool spreads or cool butterfly type structures that actually take advantage of the upside vol on vix being really expensive and you can actually earn some premium back through selling the upside so the type of structures i'm talking about are where you buy say the may vix 20 calls and you'll sell some higher strikes against them maybe the 25s or the 30s and then you'll buy something even higher just to cover your tail risk basically so it'd be like a one by two by one or two by three by one wherever the hell it is, it's like some funky broken wing call fly structure that doesn't decay badly, that you spend, you know, X amount.

24:01And if the VIX goes to your sweet spot of 25 or whatever, you make five or 10 times the amount that you spend. So you get leverage to that view, but it's quite time specific. And the reason it is done that way is so you don't just bleed carry and bleed theta like you would do otherwise, if you're just buying the futures or buying the calls. We're going to take another quick break and be right back with more of the day's top analysis on the Real Vision daily briefing.

24:30Yeah, I think it'd be time decay. Lots of questions are coming into us. Got some great ones here. Let's just jump in and start hitting these. First one comes from John Ayers from the Real Vision website. He says, everyone I respect is bearish on equities, like 3 ,600 on the S &P. When? Question mark, question mark, question mark. We should point out S &P 500 closing out the day at 4 ,092 or a fractional equivalent thereabouts. If only we knew the answer to that question. I would say a lot of shorts have been added in the near term. So sentiment's a bit bearish right now. So heading into earnings, you know, we're back at this kind of near this 4 ,200 level we got close to again.

25:12Everyone seems a lot of strategists out there seem to think that's a no-brainer sell level. so sentiment's definitely got bearish again obviously bank earnings are due I wouldn't be surprised to see a squeeze right if you ask yourself why have we rallied so much in the near term I was calling for a vol sell off into Easter and the fact that markets had got a bit panicky on the banking stuff and we were seeing measures, policy measures that were going to try and ease some of the banking stress so I was like okay vol's are selling here because you've got the seasonals working for you and you've got these guys panicking to some extent and the rates market is kind of almost forcing their hand to pause as well.

25:50So a lot of factors that were quite bullish and quite bearish for vol. But now that's, yeah, and you've had, and when that happens, when vol comes down, you get vol control people who are buying, have to buy exposure, the CTAs, the trend following guys, they've been buying, but the discretionary, the discretionary community is all pretty much sitting on their hands because they think this market, this market is a basket case and they can see the writings on the wall, right? So if we're still in that state of play and we still need to wait a while to see the data, to see the Fed, yeah, is it the last hike?

26:27Will they confirm it's the last hike in the next meeting, et cetera? Discretionary guys are not really going to be buying this market. So then it's the marginal actor is probably still the systematic types like the CTAs. And from the data that I'm seeing, CTAs are likely to still buy this thing, right? Unless there's a big sell off for some reason. So you might get April continuing to squeeze and continuing to rally. So I wouldn't be putting on bearish trades that expire in April and really counting on them working. Right. So I think if you want to put on bearish trades, you know, I'm looking at things like June as the earliest.

27:04I'm not even that convinced in doing them in equities because equities just has a habit of being overly resilient in the face of so much bearish news. right so i quite like the idea of credit i quite like the idea of hyg downside maybe doing things in hyg to the downside in june or even september to buy yourself plenty of time for the bearishness to come and the credit market to wake up to it and reprice credit spreads higher so those are the type of things so i wouldn't be in a rush to play the bear trade getting into the bear trade and getting out of your lungs makes a lot of sense but you know don't don't expect it to happen in the next few weeks, right?

27:41I'd be pretty surprised if there was anything too dramatic to the downside by then. What does your data show in terms of the CTA type commodity trading advisor versus the discretionary funds in terms of the magnitude of what's being pushed in markets right now? Yeah, like I said, I kind of lean on the reports that Goldman's put out about the CTAs, right? And And, you know, the orders of magnitude are in the tens of billions that they need to buy over the next, you know, few weeks or whatever it is, if markets are flat or higher. Right. So I'm just saying that there are pockets of time where that CTA flow is going to have more marginal impact than it otherwise would, because there's no one really offsetting it, basically.

28:28right so so if you already had some hedge funds you know we've seen that the the open interest in S &P shorts has gone up right so there's been some shorting of of futures on this rally and then we know the CTAs are probably still buyers and then you've got the asset the slower moving asset managers who are basically seeing this banking crisis come out of nowhere they're not going to be rushing to buy the market here basically they're going to be looking for that uncertainty to kind of go away. So they're just going to be in wait and see mode to see what the data looks like and what the Fed says, basically, right?

29:02We're not really going to know that until probably the June FOMC meeting. Yeah, very well explained. Next question comes from Andrew Sun on Twitter, Andrew Sun underscore 83. And the question is, inflation came down again and Fed minutes show voting members are now expecting a lower terminal rate with a mild recession. That's good news, right? Why are the indexes being sold and cryptos down today? Yeah, I mean, again, you know, you don't want to fall into that trap of thinking that every market move has to be explained by the news flow that day, basically, right? So, you know, I would say the news flow is kind of in line with what markets were already thinking and expecting and positioning for.

29:49So really, this is just a mean reversion type movement of the rally that we've seen up till now, right? Crypto's had a storming rally, right? Bitcoin smashing its head through 30K was pretty impressive. So for just to see a bit of mean reversion, and it's not even that big, right? Just a tiny bit of mean reversion for something like Bitcoin. I don't even consider it even a real move, to be honest. Yeah. And by the way, there are, to follow up on your point, sort of innumerable things that can cause short-term market gyrations, everything from positioning to just idiosyncratic types of exposure that institutions have that could cause cascade effects.