Wheaty conundrum

Upcoming economic events (Singapore Local Time):

Upcoming Economic Events (Singapore Local Time):






US GDP Annualized (Q1)



BoJ Interest Rate Decision



Eurozone HICP (April)



US ADP Employment Change (April)



Fed Interest Rate Decision



ECB Interest Rate Decision

2023-05-05 20:30 US Non-farm Payrolls (April)
2023-05-10 20:30 US CPI (April)

In the upcoming two weeks, key central bank meetings will take center stage, as investors closely monitor the Bank of Japan’s potential policy shifts and seek hints of a pause from the Fed following May’s rate hike.

Markets in Focus

Figure 1 S&P 500 Volatility Index (VIX)

The S&P 500’s realized and implied volatilities have reached their lowest since early 2022. However, with market uncertainty in play, the VIX may not remain this low for long.

Figure 2 JPY/USD Future

The Japanese Yen appears to be forming an inverse Head & Shoulder (H&S) bottom, or an H&S top in USD/JPY terms. Despite this, speculators continue to short the Yen, not anticipating an imminent move from the Bank of Japan in the upcoming monetary meeting.

Figure 3 CAD/USD

The Loonie’s performance is closely tied to crude oil prices. After the announced OPEC+ production cut, oil briefly approached $80, but the rally faltered. Consequently, the Loonie’s rally was also halted at the upper resistance of an eight-month symmetrical triangle.

Figure 4 Palladium Future (Weekly)

Figure 5 Kansas City HRW vs. Chicago SRW Spread (Monthly)

Among the four precious metals, palladium has been lagging. With the other three metals (gold, silver, and platinum) experiencing some impressive rallies lately, palladium seems to be finding support at the critical 1300 level. Could it finally be the time for palladium to shine?

The premium between Kansas City Hard Red Winter and Chicago Soft Red Winter wheat currently sits at a historical extreme. Interestingly, top reversals tend to occur in May, so it’s worth keeping an eye on these crops.

Our market views

Speaking of inflation, Japan’s March inflation rate dipped to 3.2% from January’s high of 4.3%. While still well above the Bank of Japan (BoJ)’s long-term inflation target, the slowing inflation seems to have brought some relief to the market. What’s the underlying reason? Doesn’t the market expect a surprise from the BoJ after all?

However, the devil is in the details, as is often the case. A closer look at Japan’s inflation report reveals more concerning trends. The decline in the headline inflation rate mainly resulted from lower energy costs and government subsidies on utility bills. Excluding volatile food and energy prices, the “core core” March CPI actually rose 3.8%, marking the fastest increase in over 40 years. This index is closely monitored by the BoJ as a better indicator of underlying price trends. Consequently, there remains a significant risk that the BoJ may surprise the market by adjusting its long-standing monetary policy as early as the next meeting in April. The market seems hardly prepared for that.

Switching gears to the agriculture commodity space, let’s examine the intriguing phenomenon shown in Figure 5. Kansas City Hard Red Winter wheat (HRW) typically trades at a premium to Chicago Soft Red Winter wheat (SRW) due to its higher protein content. However, the current premium is historically wide. Several factors contribute to this disparity. Cold weather negatively impacts wheat production in the US, particularly HRW wheat in the central region. If freezing temperatures cause substantial damage to hard red winter wheat, supply may tighten. The ongoing drought in the west-central and southwestern Plains is already hampering HRW wheat production. In contrast, the SRW belt has been experiencing its wettest conditions since 1979. Added to the weather dynamics are other complex factors, for example, the global export/import landscapes.

Without delving too deep into the specifics, one conclusion we can draw is that market sentiment heavily favors higher HRW prices over SRW wheat. It begs the question: how much of this has already been priced in? Interestingly, the seasonality pattern we observed in Figure 5 suggests that top reversals for the HRW-SRW spread tend to happen every 3-5 years, usually in the month of May. This pattern could indicate that it may be time to consider taking a contrarian position.

JPY’s swing amid the uncertainty around BOJ’s monetary policy, and the premium between HRW and SRW,   these two seemingly unrelated topics seem to share something in common; that is, market positioning and consensus in both cases present intriguing contrarian opportunities for traders and investors. The primary challenge, then, is constructing a trade that expresses such a view with a highly skewed risk/reward balance. 

How do we express our views

We consider expressing our views via the following hypothetical trades1:

Case study 1: short JPY 7700 x 7800 call ratio (1:2) spread

We would consider a short call ratio spread on JPY by simultaneously selling one May 0.0077 Call (JPUK3 C7700) and buying two May 0.0078 Calls (JPUK3 C7800) at a price of 0.00001. Maximum loss occurs if the underlying JPY future settles at 0.0078 at option expiry, amounting to (0.0077 - 0.0078 + 0.00001) = 0.00009. The short call ratio spread turns profitable if the underlying JPY future settles above (0.0078 - 0.00001) = 0.00779 at option expiry. Each point move in the JPY option contract equates to USD 12500000. See the payout diagram illustrated below.

Case study 2: short HRW vs. SRW wheat spread

We would consider taking a short position on the HRW vs. SRW wheat spread by selling one KE future (KEN3) at the present level of 819’6 and buying one ZW future (ZWN3) at the present level of 677’6, at a spread of 819’6 – 677’6 = 142 points. The stop-loss is above 200, which could bring us a hypothetical maximum loss of 58 points. Looking at Figure 5, if the top reversal is confirmed and the spread continues to narrow, it has the potential to fall to historical average at around 50, a hypothetical gain of 92 points. Each point move in the KE-ZW spread is USD 50. 

1 Examples cited above are for illustration only and shall not be construed as investment recommendations or advice. They serve as an integral part of a case study to demonstrate fundamental concepts in risk management under given market scenarios. Please refer to full disclaimers at the end of the commentary.

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