For two years, equity traders closely monitored the consumer price index (CPI) amid the Federal Reserve’s aggressive battle against inflation. But with inflation nearing the Fed’s target and rate cuts on the horizon, the upcoming CPI print has become less critical. Instead, the focus has shifted to a weakening labour market and the risk of a hard economic landing.
“The pivotal question for stock investors is whether the Fed waited too long to cut rates because recession risks are higher now than just two months ago,” said Eric Diton, president of Wealth Alliance. “All of a sudden, inflation is no longer the big issue.”
The S&P 500 experienced its worst week since the March 2023 collapse of Silicon Valley Bank, led by a 14% plunge in Nvidia Corp. Volatility also surged, with the Cboe Volatility Index (VIX) rising from 15 on August 30 to nearly 24 on September 6.
Despite the turbulence, options traders anticipate a relatively small move on CPI day, pricing in a 0.85% swing in either direction for the S&P 500, according to Piper Sandler data. By contrast, the jobs report triggered a 1.7% drop in the S&P 500, reflecting heightened concern about the labor market.
“Stocks have had a heck of a run this year,” Diton said. “So why not take some profits?”
Shifting Concerns
With rate cuts now considered a given, investors are more concerned about economic growth. Fed Chair Jerome Powell recently signaled the inflation fight was nearly over, and several policymakers have since indicated rate cuts are necessary. The debate now centers on how large they should be.
Friday’s jobs report showed nonfarm payrolls rose by 142,000, the lowest three-month average since mid-2020. Swaps contracts fully price in at least a quarter-point rate reduction at the Fed’s September 18 meeting. UBS data shows volatility metrics, such as skew, are elevated as traders hedge against further downside risks for stocks.
“Skew is signaling that there’s extra value in having downside protection for hedges,” said Rocky Fishman, founder of derivatives firm Asym 500. “If things disappoint from a macro perspective, the potential ride down for stocks may be more volatile this time.”
Jobs Over Inflation
Investors are now paying closer attention to employment data. The S&P 500 dropped 1.8% on August 2 after a weak jobs report, then another 3% on August 5. Meanwhile, inflation data released two weeks later prompted only a 0.4% rise in the S&P 500.
Demand for out-of-the-money put options relative to calls has increased, according to UBS. The VIX is also 52% higher than its 2024 average, suggesting elevated risk for the coming months.
With the Fed in a quiet period ahead of its next policy decision, no further commentary is expected until September 18. However, the central bank’s Beige Book revealed that businesses are more concerned about slowing growth than inflation.
The Atlanta Fed’s GDPNow model projects third-quarter growth at 2.1%, down from roughly 3% weeks ago, adding pressure on the Fed to cut rates before a recession hits.
