What the Options Market is Telling Us About May CPI

Tomorrow morning, the Bureau of Labor Statistics (BLS) releases the Consumer Price Index (CPI) for the month of May.  I refrain from using the phrase “eagerly awaited”, since I’m not sure who is eager about seeing an inflation report that is widely expected to be stubbornly high, but inflation has permeated all our psyches.  If it’s bad news, we might as well hear it.  And if it’s good news, well, we’d like to hear it.

According to Bloomberg data, CPI is expected to rise 8.2% on a year-over-year (YoY) basis and 0.7% on a month-over-month (MoM) basis.  Those compare to 8.3% and 0.3% for April, respectively.  The so-called “core” CPI, which exclude food and energy, are expected to rise 5.9% YoY and 0.5% MoM, versus 6.2% and 0.6% for April.  We will also be looking for Real Average Hourly Earnings, which fell 2.6% on a YoY basis in April. 

The real wage statistic goes a long way to explaining why so many people seem so miserable even amidst a tight labor market.  The April statistics imply that nominal wages rose over 5% yet failed to keep up with inflation. 

Bear in mind that while headline CPI is a very important statistic, since there are many payments that are pegged to changes in CPI, it is not the Federal Reserve’s preferred inflation metric.  That honor goes to the PCE Core Deflator.  That showed a rise of 4.9% in April, along with a headline rise of 6.3%.  There are various reasons why CPI and PCE diverge, but it is quite possible that the FOMC is reflecting lower levels of inflation in their decision-making rubric than the public.  It is also important to remember that even though economists prefer to remove volatile food and energy prices[i] in their calculus, most individuals don’t have that luxury.  In fact, those are the prices that are creating much of the anxiety about inflation. 

None of this is intended to make us dismissive about tomorrow’s CPI release.  Inflation is simply too pervasive to ignore.  We need to look at how traders are pricing in their expectations for the outcome, and for that we look to options expiring tomorrow (June 10, 2022) on the SPDR S&P 500 ETF (SPY).  First, we will use the IBKR Probability Lab to check where the most likely outcomes are anticipated:

IBKR Probability Lab for June 10^th SPY Options, as of June 9^th

Source: Interactive Brokers

We see that the peak probabilities are close to the current price of 409.30 – in the 410-411 range.  That is mildly bullish, but not overly so.  We also see that the at-money implied probability is 1.91%.  That seems high, but it is hardly out of character for the S&P 500 (SPX) to have a 2% intraday move in recent sessions (the most recent was on Tuesday). 

We also see that volatility skew is relatively flattish, at least around the money, as shown below.  That implies only modest risk aversion:

Multi-Expiry Skew for SPY, June 10th expiry (green), June 17th (yellow), July 15th (orange)

Source: Interactive Brokers

Finally, we see that skew has remained relatively constant, with the notable exception of a parallel move higher during today’s trading.  That isn’t at all surprising, given today’s focus on tomorrow’s CPI:

Time Lapse Skew in SPY Options Expiring June 10th, 2022, as of June 9th, 8th, 1st (top to bottom)

Source: Interactive Brokers

Bottom line – if you’re paying any attention at all to financial media, tomorrow’s CPI report is a key source of concern and a key driver about perceptions regarding future Fed activity.  The options market is less convinced.  Traders are pricing in a bit of extra volatility for tomorrow, but not enough to imply that they are particularly worried.   Interpret that relative complacency as you will.

—

[i] Yet another in a long series of reminders that volatility counts in both directions