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Long post, so TLDR is that I’ll likely trim a bit ahead of the macro data, while the AI trade can probably remain strong into Thursday/Friday. CPI is likely to create a knee-jerk reaction if the headline comes in higher, but if core is softer I’d expect that move to fade and potentially create the environment for another squeeze higher but we need the data. VIX tail hedging is very active
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I was expecting a considerably softer payrolls number, so the +172k headline was clearly stronger than my base case and, at face value, enough to keep the tightening discussion alive at the FOMC particularly for Q4.
Still, I would be careful about treating it as evidence that labour demand is reaccelerating as much of the upside came from rebounds in local government and Leisure & Hospitality employment, alongside the usual strength in Healthcare, while a rather favourable seasonal adjustment also flattered the print.
The important thing is that wage growth slowed to a cycle-low 3.1% YoY even as hours worked increased, meaning that labour costs are not creating meaningful inflation pressure.
https://preview.redd.it/a55cbi46b9oh1.png?width=1461&format=png&auto=webp&s=64eb80fb3722aac4aebafe9d3e253cc1e571b02a
So, while the headline was stronger than I expected, the underlying picture remains closer to “no hire, no fire” than an overheating labour market and a soft(ish) core CPI should still clear the bar for a September hold, although the possibility of a Q4 hike is becoming harder to dismiss.
Now, the upcoming risk events include the aforementioned CPI on 9/11, the FOMC on 9/16, and quarterly triple witching OPEX on 9/18. While these dates bring the potential for market volatility expansion I will be looking at AI names to increase expousre, similar to the Bloom Energy Trade from last week.
The August headline CPI will likely look uncomfortable and probably print north of 0.3% MoM but I expect most of that pressure is likely to come from energy and not any reacceleration in underlying demand.
On core, I am leaning towards 0.2% MoM or lower and that would bring the YoY rate down from 2.5% to 2.4%, with a fairly decent probability that we get all the way to 2.3%.
Headlne, however, is much more likely to come in hot because of the energy component.
For the Fed meeting, I think a soft-ish core print clears the bar for a HOLD. That said, I am now becoming more open to the possibility of a hike later in Q4 if the inflation data stop improving or if energy pressure starts bleeding into the broader inflation basket.
What is interesting here is just how uniform Wall Street expectations are - there are 35 economist estimates for core CPI, with a median of 0.2%, an average of 0.22%, a high of 0.3%, a low of 0.1% and a standard deviation of only 0.04%. Headline is almost identical in terms of dispersion with 34 estimates, a median of 0.4%, an average of 0.38% and again only 0.04% standard deviation.
https://preview.redd.it/u6de7i18b9oh1.png?width=983&format=png&auto=webp&s=5c1d4e6a98bf6f6bfa9f136217a198b3acfad0cb
In other words, the Street has decided that this is a relatively low-uncertainty print, which is always an interesting setup going into what is effectively a binary macro event.
Following the softer July print, another 0.2% core number would reinforce the underlying disinflation trend and weaken the case for another hike, even if the hotter headline number initially creates a negative market reaction. So that’s what you should focus on when the print comes out
Raising rates in response to an energy-driven supply shock would do very little to lower crude prices or increase refining capacity and what it would do is weaken housing, capital spending and hiring, effectively layering a domestic demand shock on top of an external supply shock.
The instinct to respond aggressively to higher headline inflation is probably still rooted in the inflation trauma of the 1970s, but the conditions today are very different because we do not have widespread wage indexation, we do not have an uncontrolled acceleration in core inflation and there is still no clear evidence that inflation expectations have become unanchored.
High-yield credit spreads also remain low, but that only tells us that the system has not cracked yet and it is not an invitation for the Fed to continue testing how much tightening the economy can absorb.
https://preview.redd.it/qa93i669b9oh1.png?width=1080&format=png&auto=webp&s=3b70f3293fc3e169c77616b3c690b091e5905491
Cross asset stress, perticularly Funding and Credit also remain low
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All of this leaves us with a fairly interesting positioning setup -with about 60bps of hikes already priced into the curve, while speculative positioning remains long the dollar and short the Nasdaq, a soft core CPI print or any meaningful geopolitical de-escalation could trigger a fairly sharp squeeze in Treasuries and technology stocks, while pushing yields and the dollar lower.
https://preview.redd.it/eqljvrkab9oh1.png?width=1188&format=png&auto=webp&s=5a64238e29453ef9a1e21b812ac54df753c5ec56
So the headline may look bad, and I would not be surprised if the initial market reaction focuses on exactly that but if the underlying inflation data remain soft, I think the risk-reward increasingly starts favouring the more benign interpretation which is that the energy shock is pushing headline inflation higher, while the underlying disinflation trend remains intact.
Do note that despite the CPI being the main event, PPI comes Thursday, September 10, one day before that and several PPI components feed directly into the eventual core-PCE calculation.
In terms of conviction flows, for now the strong semiconductor and AI related trade remains strong similar to what I posted at the start of last week but do note activity picked up on high convexity for the VIX - four VIX calls were bought, all directional premium, with roughly $25m net and the two largest prints were November 34 and 31 calls more than 100% OTM.
https://preview.redd.it/dsgs82tbb9oh1.png?width=1086&format=png&auto=webp&s=6af1234362868e42a21dbc335952c8221844718a
I would treat that as concentrated convexity/tail hedge for the events mentioned at the start of the post and as it plays into the potential weakness in September caution is in order and the smaller position sizing remains and I will be trimming some of the SPY longs from 760 in preparation for the CPI and potential weakness and will continue to do so as the release approaches
On to SPY positioning - $770 is the first support while $760 remains the main one. As the index has moved into a positive vol scenario, market makers will buy dips and sell rallies. Resistance has moved to $780
https://preview.redd.it/y8s7pgncb9oh1.png?width=783&format=png&auto=webp&s=adfebd6d645498738c68b7d810561b371c0ffaaa
But do note that flows up to 18 DTE are neutral and more aggressive on $770 and $760.
Qs main level of resistance is at #730 but do note that the vol regime here is still negative below $721 which means that market makers will sell when the price falls and vice versae. On the shorter DTEs this is leaning more bullish, so what we could see is semis and the AI trade lead higher until Thursday/Friday.
https://preview.redd.it/wjxk6l8eb9oh1.png?width=786&format=png&auto=webp&s=50036d25799cfde41aaf6cbe6ccbf250a3d389a0
VIX bullisg volumes are on the higher side, so remain cautious and trim into strenght
https://preview.redd.it/kdbzqqxeb9oh1.png?width=787&format=png&auto=webp&s=52f4c29060fbbc4e962ebdc35dbb29e203b53274