OTC Desk Market Update: Crypto Volatility — BTC and ETH Trends Ahead of FOMC
Welcome back to our weekly market update! Here are the top things we’ll be paying attention to this week:
- U.S. CPI Inflation Report on Wednesday
- U.S. Federal Reserve Press Conference on Wednesday
- U.S. Initial Jobless Claims Report on Thursday
- Options Expiry on Friday
Macro Update
Robust Job Growth and Wage Increases
The U.S. Bureau of Labor Statistics reported a surprising surge in job growth and wage increases for the month of May. Nonfarm payrolls increased by 272,000, significantly higher than the expected 190,000, while average hourly earnings rose 4.1% over the past 12 months, exceeding projections. This robust data signals a vibrant labor market and adds to the narrative that the Federal Reserve may not need to rush into lowering interest rates.
Inflation Remains Above Target
Despite the strong employment figures, inflation continues to run above the Fed’s 2% target. Most gauges indicate prices rising annually at about a 3% rate, down from the peaks of mid-2022 but still elevated. This factor, combined with the lack of evidence that higher rates are endangering broad economic growth, suggests that the Fed’s dual mandate of maintaining full employment and stable prices is not yet fully met.
Lowering Expectations for Rate Cuts
In response to the jobs report, futures traders reduced their bets on rate cuts. Pricing in fed funds futures markets indicated almost no chance of a reduction at the upcoming Federal Open Market Committee (FOMC) meetings in June and July. The probability of a September move was around 50%, and the chances of a second cut before the end of the year were only about 46%, according to the CME Group’s FedWatch measure.
Balancing the Fed’s Mandate
While the strong job market and elevated inflation may temper expectations for immediate rate cuts, some experts believe the Fed can still lower rates later this year. Rick Rieder, Chief Investment Officer of Global Fixed Income at BlackRock, pointed to softness in demand for labour and a trend of part-time employment outpacing full-time positions as indicators that the Fed’s mandate of price stability and full employment is coming into balance.
Revised Expectations for Rate Cuts
Citigroup, previously expecting aggressive rate cuts, now sees the Fed not moving until September but then continuing to cut rates from that point. The firm believes that the slowing hiring demand and broader economic deceleration will ultimately provoke the Fed to react with a series of cuts beginning in the next few months.
Overall, the May jobs report and wage data have led to a reassessment of expectations for Fed rate cuts. While the robust labor market and persistent inflation may delay immediate action, many experts still anticipate the Fed will lower rates later this year as economic conditions evolve and the central bank seeks to balance its dual mandate.
Crypto Market Overview
Weekly and Monthly Returns (%)
Implied and Realized Volatility
Realized volatility in the crypto market has remained relatively low, with the sell-off on Friday only able to push realized volatility to the high 30’s. Both major assets have seen their realized volatility plummet to the mid-30s, with Ethereum (ETH) maintaining levels around 30. Implied volatility for the one-month bucket has similarly decreased by approximately two volatility points for both Bitcoin (BTC) and Ethereum. Friday’s sell-off was only able to take implied vol to the mid-60’s. Notably, Bitcoin’s weekly implied volatility has shown a slight increase, bouncing back from oversold conditions due to upcoming macro events like the U.S. Consumer Price Index (CPI) report and the latest FOMC meeting.
The carry in both Ethereum and Bitcoin has turned deeply positive, with a magnitude of around 20 volatility points, attracting traders looking to sell gamma under the expectation that markets will remain within certain ranges. This can reflexively feed back into lower volatility as this becomes the dominant position in the market.
Term Structure and Skew
Bitcoin Term Structure
Bitcoin’s term structure has seen minor shifts, with the longer part of the curve slightly lower by about half a point. Weekly expiries, particularly from June 7th to June 21st, have held up better, maintaining levels in the mid-40s. Overall, the changes in term structure are minimal, traders use this as an indicator to sell gamma more confidently as they expect a range-bound market.
Ethereum Term Structure
Ethereum’s term structure has continued to collapse into contango, with the front end dropping by approximately nine to ten volatility points. The middle of the curve has seen a decrease of around 23 points, while the back end has drifted lower by about one to one and a half points. Calls in Ethereum, especially for short-term expiries, have remained firm, trading at a premium with front-end calls holding at around four points.
Skew
Skew has shown signs of recovery, moving back towards call skew across the curve. This recovery is modest, with front-end expiries exhibiting a slight uptick in call skew by about one to one and a half volatility points. Ethereum’s skew continues to hold a premium over Bitcoin across the entire term structure, indicating that traders expect Ethereum to out-perform Bitcoin once ETF inflows commence.
Options Flows and Positioning
Recent options flows indicate a shift in market positioning. There has been a notable increase in risk reversal flows, although not substantial enough to significantly move the skew. This suggests that hedging activity is beginning to accelerate, likely in anticipation of upcoming macro events like the CPI inflation report and the FOMC meeting.
Given the current market conditions, and the prevalence of short volatility trades, particularly through spread trades or other hedged positions, has left market makers long gamma. This contributes to the subdued volatility environment based on the manner these dealers have to hedge their positions. The significant decline in volatility and the lack of a realized/implied volatility spike on Fridays’ sell off is an example of how this kind of positioning can contribute to market moves. Traders are now favouring structured trades like short Vertical Spreads, short Butterflies, and short Iron Condors in an attempt to capitalize on the current volatility environment.
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.
