OTC Desk Market Update: U.S. CPI and Crypto Volatility - Preparing for Market Shifts
Welcome back to our weekly market update! Here are the top things we’ll be paying attention to this week:
Macro
Inflation Eases Slightly in April
U.S. Inflation saw a slight decrease in April, providing a small respite for consumers, though it remains higher than levels that would suggest an imminent interest rate cut. The Consumer Price Index (CPI), which measures the cost of goods and services at the cash register, rose by 0.3% from March, slightly below the anticipated 0.4%. Annually, the CPI increased by 3.4%, aligning with expectations.
Core Inflation Data
Excluding food and energy, the core inflation rate was 0.3% monthly and 3.6% annually, both as forecasted. This core inflation reading was the lowest since April 2021, and the monthly increase was the smallest since December. Positive market reactions followed the CPI release, with major stock indexes rallying and Treasury yields falling. Futures traders increased the probability that the Federal Reserve would start cutting interest rates by September.
Key Drivers of Inflation
Price gains in April were driven significantly by increases in shelter and energy costs. Shelter costs, a critical concern for the Federal Reserve, rose by 0.4% monthly and 5.5% annually. The energy index increased by 1.1% monthly and 2.6% annually. Food prices remained flat for the month but rose 2.2% annually. Conversely, prices for used and new vehicles, which had surged during the pandemic, fell by 1.4% and 0.4%, respectively.
Retail Sales Disappoint
Consumers continued to feel the impact of higher prices in April. Retail sales showed no change from March, which had been revised to a 0.6% increase. Annual sales were up 3%, while sales excluding autos rose by 0.2%, matching expectations. Online sales declined by 1.2%, and sporting goods and related stores saw a 0.9% decrease. However, gasoline stations reported a 3.1% increase due to higher pump prices, and electronics and appliances sales rose by 1.5%.
Statements From Federal Reserve Officials
Fed Chair Jerome Powell acknowledged that inflation readings earlier in 2024 were higher than expected and suggested that current monetary policy might need to remain in place longer. Financial markets have interpreted this to mean that the Fed may wait until at least September for more favorable inflation data before making any rate cuts, potentially the first since the early days of the COVID-19 pandemic.
Long-Term Perspective
The Fed raised the overnight funds rate 11 times from March 2022 to July 2023 to reduce demand that fueled inflation to its highest in over 40 years. Policymakers initially believed inflation would subside as pandemic-related supply chain issues resolved, but strong demand driven by fiscal and monetary policy stimulus has kept price pressures elevated.
Crypto Market Overview
Weekly and Monthly Returns (%)
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Implied and Realized Volatility
Realized volatility continues to fall lower, as evidenced by the chart below indicating a drop from around 50 to the high 30’s for Bitcoin (BTC). Ethereum's (ETH) volatility also experienced a decline, now standing at around 45. This reduction in realized volatility has led to a positive carry, empowering gamma sellers due to the spread between higher implied volatility and lower realized volatility. Similar to realized volatility, implied volatility has also decreased to the mid 40s after pricing in an 80 vol reading before the CPI announcement. The volatility crush that happened afterwards helped fuel the rally in digital assets as market-makers were forced to buy back their hedges as volatility fell.
Term Structure and Skew
Term structure shows a flatter curve for Ethereum compared to Bitcoin, which exhibits a steeper contango. The back end of both ETH and BTC’s term structure has shifted higher about 5 vols from a week ago indicating increased demand for crypto options in the longer-dated expiries. The absence of an Ethereum ETF event also contributes to this outlook, with a preference for selling short-dated options against longer-term holdings. Skew has been relatively flat heading into the week for both Bitcoin and Ethereum. Last week's headline risk (CPI) created put demand as traders began to hedge their portfolios accordingly by purchasing downside protection. That same demand for out-of-the-money puts in the shorter expiries is non-existent going into this week, leaving the curve relatively flat. However, the longer-term outlook remains optimistic, with upside call options gaining preference as we move further into the year.
Options Flows and Positioning
Bitcoin
Bitcoin options flows have decreased by 35% to $5.5 billion USD, with volatility drifting down after the CPI inflation report. Block trades indicate buying interest, particularly in puts ranging from $60,000 down to $50,000 USD, and calls from $65,000 up to $90,000 USD for June. The notable trade was a June $80,000-$90,000 USD call spread. On-screen trading has generally been selling, while block trades focused on buying optionality. Gamma positioning shows Bitcoin is slightly short, with high short concentration around $65,000 USD strike, which we went through in pretty short order, showing how much these market-maker flows can impact momentum. Other short strikes in BTC include the $70,000 and $75,000 USD price levels.
Ethereum
Ethereum flows also dropped by 40% to $3.5 billion USD, dominated by protective put buying. Significant trades included May $3,000 USD puts and a June $2,927/$3,400 USD put spread collar, reflecting the cautious outlook traders had heading into CPI. Ethereum dealer gamma has moved towards neutral due to increased put buying, with potential for long gamma if the market rallies back to $3,300 USD and dealers are supplied with volatility from call buying.
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Disclaimer: This article is not intended to provide investment, legal, accounting, tax or any other advice and should not be relied on in that or any other regard. The information contained herein is for information purposes only and is not to be construed as an offer or solicitation for the sale or purchase of cryptocurrencies or otherwise.