You know the drill, even if you’ve forgotten it. But thanks to Larry McDonald updating a Tweet of his from last Summer, here’s a reminder:
Here we go again
— Lawrence McDonald (@Convertbond) July 20, 2016
Here was a chart that I posed in this space on June 9th that speaks to the relationship of the Fed’s attempt to normalize interest rates and knock-on effects of the dollar and commodities:
As we head into the Fed’s rate meeting next week, and with the U.S. Dollar Index (DXY) at 4 month highs, Crude Oil at 3 month lows, the VIX at 2016 lows, the yield on the 10 year Treasury bond having just bounced off of all time lows, and the S&P 500 (SPX) at all time highs; the question now is whether or not we are setting up for another all too familiar volatility shock? There is always the chance that the greater the frequency of the convergence of these events the less volatile reaction, and I suspect the Fed will do or say little to rock the boat. Fed Fund Futures are pricing an 8% chance of a rate increase at next week’s meeting, and a 25% of an increase at their next meeting on Sept 26th. If the July payrolls number comes in hot in early August, then the U.S. dollar will continue to rally as expectations for a Fed rate increase will build, which could cause oil to go lower, fears of global economic risk rise, chances of corporate defaults (particularly in energy and materials) tick up again, emerging market currencies weaken, and as Larry intimated in his tweet from last August, that puts the Fed on hold again. Lather, rinse, repeat.
For what it’s worth, index options traders don’t seem too bothered by the FOMC meeting next week. Using the at the money straddle in the SPY (the call premium + the put premium), the options market is implying only a 1.2% move in either direction between now and next Friday’s close (two trading days after the conclusion of the FOMC meeting). With the SPY at $217 the July 29th weekly 217 straddle is offered at $2.55, if you bought that, and thus the implied move between now and next Friday’s close, you would need a rally above $219.55 or below $214.45 to make money.