Source: Zhitong Finance

From J.P. Morgan Chase to Citigroup, the trading business departments of Wall Street's most famous commercial banks are urging investors to prepare for the sharp shock in the US stock market this week. After investors experienced relatively lackluster trading days in the recent stock market, huge market fluctuations will soon be revealed this week. The latest US CPI inflation data and the Federal Reserve's latest interest rate decision will be announced this Wednesday EST. J.P. Morgan's trading business department lists possible fluctuations in US stocks after the inflation data is released; the Citigroup trading department expects the implied volatility caused by CPI and the Federal Reserve's interest rate decisions to rise sharply.

Andrew Tyler (Andrew Tyler), head of US market intelligence from J.P. Morgan's trading department, said that the US stock options market is betting on the US stock benchmark index, the S&P 500 index, which is expected to fluctuate 1.3% to 1.4% in both directions before Friday. This expected fluctuation is based on affordable cross-option prices due on the same day, reflecting the intense long and short game in the market. The vast majority of these fluctuations are expected to occur after the consumer price index (CPI) data report released on Wednesday morning EST (Wednesday evening Beijing time) and the policy interest rate decision announced by the Federal Reserve on Wednesday afternoon (early Thursday morning Beijing time).

Taylor and his trading team wrote in a report to clients on Monday: “Since the CPI and the Federal Reserve interest rate decision will be announced on the same day, the Fed's latest interest rate bitmap, as well as Federal Reserve Chairman Powell's remarks at the press conference, may reverse the market fluctuations shown by CPI.”

The “affordable cross-option that expires on the same day” described above is an options trading strategy. It means that traders buy a call option and a put option at the same time, and both have the same strike price (strike price) and are often close to the current market spot price (spot price) of the underlying asset. Statistics from J.P. Morgan's trading department show that the latest affordable cross-option prices basically reflect that the market has high uncertainty and expected volatility in upcoming economic data and median interest rate bitmap, and the long and short game is extremely intense.

The above strategy is usually used when traders expect significant market price fluctuations, but are unable to determine the direction of fluctuation. This setting allows at least one option contract to obtain higher returns when the spot price of the option changes significantly. If the underlying price rises sharply, buying a call option will bring profit; if the underlying price falls sharply, then buying a put option will bring profit. Although this strategy can profit when the market price fluctuates greatly, investors will lose the option fees they have paid if the price remains relatively stable.

J.P. Morgan looks forward to the trend of US stocks on the “CPI release date” - the increase may be as high as 2.50% under the most optimistic circumstances

According to economists' forecast data compiled by the agency, the overall CPI, including food and energy prices, is expected to increase by 3.4% year on year, which is basically the same as in April. The overall CPI is expected to rise 0.1% month-on-month, down from 0.3% in April. On the basis of excluding the “core CPI” of food and energy prices, economists generally expect the core CPI to rise 3.5% year on year, down from the 3.6% increase in April; economists expect the core CPI to increase 0.3% month-on-month, which is basically the same as last month.

This data will be released a few hours before the Federal Reserve announces its latest interest rate policy decision. The market generally expects the Fed to keep the benchmark interest rate unchanged at the highest level in 20 years at this meeting. The main focus of the market is on the Federal Reserve's latest Economic Forecast Summary (SEP), in particular the interest rate “bitmap” given by Federal Reserve officials and comments from Federal Reserve Chairman Powell. The “median interest rate forecast chart” shown in the former depicts the Federal Reserve policymakers' unanimous expectations for future interest rate trends.

Based on all possible expectations, the J.P. Morgan trading team anticipates that the US stock market may experience sharp two-way fluctuations on the “CPI announcement date+the Federal Reserve Interest Rate Decision Date”, while the global stock market will be similar to the final trading situation of the US stock market on the same day.

According to the J.P. Morgan trading team, the most likely scenario on the “CPI announcement day” is that the core CPI will increase in the range of 0.3% to 0.35% month-on-month, with a probability as high as 40%. At that time, the S&P 500 index may fluctuate 0.75%; the second-most likely scenario is 0.25% to 0.3%. The expected probability is as high as 25%.

According to the J.P. Morgan trading team, the most optimistic increase range for the S&P 500 index is expected to be 1.75% to 2.50%, but this is the lowest probability situation, only 2.5%, and the required core CPI increase is only 0.2% month-on-month; the most pessimistic decline range for the S&P 500 index is expected to fall 1.5% to 2.5%. This is the second-lowest probability situation. It is only 5%, and the required core CPI increase more than 4% month-on-month.

J.P. Morgan Chase Formulates Countermeasures on “CPI Announcement Day” - Scenario analysis provided by the commercial bank's trading department for the US stock market

The core CPI fell in the 0.20% to 0.25% month-on-month range, which is expected to stimulate the rapid rise in interest rate cuts in September

Taylor stressed that if the US core CPI rises by more than 0.4% month-on-month in May, it may trigger a short-term sell-off of all risk assets such as stocks, and the S&P 500 index is expected to fall by 1.5% to 2.5%. But he thinks there's only a 5% chance that this will happen.

The core CPI excludes volatile food and energy components and is regarded as a better measure of potential inflation than the overall CPI index. Economists generally expect the core CPI for May to rise 0.3% from the previous month.

Taylor wrote that if the core CPI is between 0.3% and 0.35% month-on-month — which is the most likely scenario the J.P. Morgan trading department expects — the S&P 500 will eventually fluctuate between a 0.75% decline and 0.75% increase. Taylor said this will depend on the progress of “anti-inflation” housing prices in the US, as well as rising trends in automobile and medical prices.

Taylor also stressed that if the core CPI is only between 0.20% and 0.25% month-on-month, then market expectations for the Fed's interest rate cut in September may soar rapidly, and the US stock market will begin a new round of upward spree. He explained that after the ECB cut interest rates for the first time in 5 years last week, some traders even bet that the Federal Reserve's July interest rate cut would be an “accident insurance” for the market.

Notably, the sharp rise in the number of non-farm payrolls in the US in May and the announcement of salary increases that exceeded expectations last Friday prompted traders to drastically delay the potential schedule for the Federal Reserve's interest rate cut when the relevant data was released last week. After the announcement of the number of non-farm payrolls that far exceeded expectations last Friday, the Fed's interest rate cut expectations have cooled down sharply. Currently, the interest rate futures market is only betting on the Federal Reserve's interest rate cut expectations for December. Expectations for September interest rate cuts have completely declined before the non-farm payrolls announcement.

According to a report released by Bank of America last week, for US stock bulls, the “suitable range” for the number of new non-farm payrolls in May was 125,000 to 175,000 (the actual data released last Friday was 272,000). If this target is achieved, then the US stock market may experience a wave of rebound. If it falls below or above, it will trigger a wave of sell-off.

Taylor from J.P. Morgan Chase added that any month-on-month inflation data below 0.2% would be viewed as a major benefit for the US stock market, triggering the S&P 500 index to rebound 1.75% to 2.50% in the US stock market.

Meanwhile, Stuart Kaiser (Stuart Kaiser), head of US stock trading strategy from Citigroup, said that it is best for investors to prepare for stock market fluctuations on the day of the Federal Reserve's interest rate decision. The head of trading strategy anticipates that this may be the largest fluctuation in the US stock market since March 2023.

At a time when the possibility of large fluctuations in the stock market surrounding the CPI report and the Federal Reserve's interest rate decision appeared, market volatility indicators have always been suppressed until then. The Chicago Board Options Exchange (Cboe) Volatility Index (VIX Index) is currently close to a 52-week low, 13 which is far below the 20-point level that has begun to cause concerns among options traders.