OTC Desk Market Update: Countdown to Clarity — Market Volatility Ahead of the Fed’s Rate Decision
Welcome back to our weekly market update! Here are the top things we’ll be paying attention to this week:
- U.S. ISM Manufacturing PMI Data on Wednesday.
- U.S. FOMC Meeting & Interest Rate Decision on Wednesday.
- U.S. Initial Jobless Claims on Thursday.
- U.S. Non-Farm Payrolls Report on Friday.
- Options Expiry on Friday.
Macro
Weak Economic Growth and Rising Prices
The U.S. economy grew at a slower pace than expected in the first quarter of 2024, with GDP increasing at an annualized rate of 1.6% when adjusted for seasonality and inflation. This was significantly lower than the 2.4% growth rate economists had predicted and a sharp decline from the 3.4% and 4.9% gains in the previous two quarters.
Inflation Concerns
Inflation also rose at a faster pace than expected, with the Personal Consumption Expenditures (PCE) price index increasing by 3.4% on an annualized basis, its biggest gain in a year. Core PCE, which excludes food and energy prices, rose even more sharply at 3.7%, well above the Federal Reserve’s 2% target. The GDP price index also increased by 3.1%, slightly higher than the 3% estimate.
Impact on Markets and Monetary Policy
The weaker-than-expected growth and higher inflation figures caused markets to slump, with the Dow Jones Industrial Average futures falling more than 400 points. Treasury yields also moved higher, with the benchmark 10-year note reaching 4.69%. The report has significant implications for the Federal Reserve’s monetary policy. It forces Fed Chair Jerome Powell into a difficult position at the upcoming Federal Open Market Committee (FOMC) meeting, as the central bank struggles to balance economic growth and inflation. Investors have had to adjust their expectations for when the Fed will start cutting interest rates, with futures markets now pointing to just one rate cut in 2024.
Crypto Market Overview
Implied and Realized Volatility
Both implied and realized volatility have declined for Bitcoin (BTC) and Ethereum (ETH). After significant price fluctuations in the previous weeks, realized volatility for Ethereum soared to around 100 but has since started to normalize as market movements become more orderly. Currently, Bitcoin’s realized volatility has settled in the mid-30s, while Ethereum’s has adjusted to the mid-40s. Concurrently, short-dated implied volatilities have experienced substantial reductions, with one-month volatilities decreasing by two to three points and weekly volatilities dropping by five to ten points.
What’s interesting is the correlation between spot prices and implied volatility, which is typically positive during rallies and then becomes negative during drawdown periods as we witnessed this last month. This is due to the volume of short-dated options (calls during rallies and puts during drawdowns) that are being purchased during those periods. After a sell-off however, volatility tends to grind lower as price stabilizes and once a key level is breached the correlation becomes positive again. For instance, if Bitcoin were to approach the $70,000 USD mark and Ethereum were to rise towards $3,600 USD, a further grind lower in volatility is what the historical data shows we should expect. But if price should break above these levels, an increase in volatility could be expected, as traders begin purchasing short-dated calls to capture upside, based on the historical dataset.
Term Structure and Skew
Term structure for both Bitcoin and Ethereum are now firmly in contango as realized and implied volatility fall, particularly in the front end of the curve. This shift is especially notable after halving events due to a marked reduction in implied volatility as options that were purchased to capture volatility around the event expire.
Skew shifted towards neutral from a previously deep put premium. Skew in crypto markets is typically influenced by short-dated option purchases. Neutral skew indicates traders are balanced across call and put exposure with no bias in terms of market direction. Though Ethereum’s put skew has faded, it still maintains some put premium extending into May, suggesting a cautious outlook among traders about potential downside risks.
Options Flows and Positioning
Option volumes increased this week, particularly in Bitcoin, which rose to approximately $9.8 billion USD in options traded. Strategies have included buying puts and put spreads for the April to May expiries in both assets, indicating traders protecting against further declines with the Fed rate decision on the horizon. Conversely, we are beginning to see an increase in call option purchases, with notable buys at the $70,000 USD strike in BTC and the $4,000 USD strike in ETH.
Gamma positioning has become a focal point, with Bitcoin showing a growing short gamma position, doubling over the past week. This setup suggests that depending on where price is at expiration, there is increasing potential for a gamma squeeze, which occurs when market makers are forced to hedge in the direction of market momentum. Ethereum’s gamma positioning, however, remains relatively flat which has been the case for the majority of the year so far.
As always, our team is here to assist you and provide services tailored to your specific needs. If you would like to discuss these topics further, we invite you to book a meeting with our team.
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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.
