Summer Doldrums Taking Hold

Yesterday’s equity market was a generally dull one.  Today’s, unfortunately, is not exactly shaping up to be exciting either.  We were able to blame yesterday’s lack of activity on a paucity of catalysts to spur activity on a late-summer Monday.  The story is similar today, except that Tuesdays lack the sense of ennui that often accompanies Mondays.  Put simply, there has been a lack of catalysts on a popular vacation week.  Tomorrow’s CPI and Thursday’s PPI reports might wake things up – including the somnolent VIX.

The CPI report is always among the most closely watched economic releases.  Although the Federal Reserve has an announced preference for the Core PCE Deflator (and Chair Warsh seems to favor trimmed mean measures), the change in the Consumer Price Index is the most relevant for many individuals – particularly those who have payments linked to that measure.  It is often misunderstood, however, since we all tend to conflate the changes in CPI with the index itself.  As we explained last year:

It is important to keep the Consumer Price Index (CPI) in perspective.  We commonly think of CPI as measuring inflation, but it actually measures the level of prices in the economy.  Instead, it is the change in that index over time that measures inflation.  It is better to think of the CPI like the S&P 500 (SPX).  SPX is a measure of the level of stock prices.  When SPX rose by 0.3% yesterday, we didn’t say that stock price inflation was 0.3%, but we could have.  It is the same idea, except that we like stock price inflation (“socially acceptable inflation?”).

The economist consensus for the monthly increase in headline CPI is 0.1%, while the consensus for the monthly core increase is 0.2%.  Both would be higher than last month’s moves of -0.4% and 0.0%, respectively.  Yes, we had modest headline deflation in June, thanks to a reduction in energy prices from recent highs, while those benefits apparently spread to other sectors of the economy affected by the core.  Traders on IBKR Prediction Markets seem more optimistic than most economists, since there is only a 24% “Yes” for a Core CPI increase above 0.2%.  (If they matched the consensus, that number would be about 50% and the “Yes” for above 0.1% would be even higher than 71%.)

1-Month, IBKR Prediction Markets for July Monthly Core CPI Increase

Source: Interactive Brokers

As for the low levels of the Cboe Volatility Index (VIX), it is important to remember that VIX is not a “fear gauge,” even if it seems to play one on TV.  Instead, this is when it is important to remember that its calculation uses S&P 500 (SPX) options to measure the market’s best estimate of volatility over the coming 30 days.  Put simply, it’s hard to expect much volatility over the coming 30 days.  The bulk of earnings season is behind us, and the only major communication from the Fed is likely to occur at the annual Jackson Hole conference in more than two weeks.  Correlations remain relatively low, which also pressures the level of VIX, but they’ve risen recently without taking VIX along with them.  Options traders are not so much fearful as they are bored.

3-Months, VIX (red/green daily candles), COR1M (blue line)

Source: Interactive Brokers