While the hard de-risking of Friday has seen a calming overnight (thanks to a ‘meh’ China RRR cut), The Fed’s recent coordinated messaging-shift to “inflation fighter” remains top of mind for most investors.
A smorgasbord of Fedspeak late last week made it clear that The Fed has:
a clear desire for an accelerated taper (double-up to complete by March) in order to…
…liftoff the policy rate sooner (commence June?)
For now it’s working as the market is fully pricing-in a rate-hike by June…
Nomura’s Charlie McElligott warns that the sudden flip-flop jawboning has risk-assets “stuck” in a deleveraging and exposure reduction cycle, particularly for a market parked in crowded “easy-policy” trades (like leveraged “bond” proxies of “Secular Growth” profitless Tech)…
…and against a general complacency as it pertains to the Fed’s ability or willingness to tighten as per recent scar-tissue of the past decade (conditioned by the “Fed Put” and their intolerance for pain since the ’08 crisis—i.e. the policy reversals seen around the Taper-Tantrum in ’13, the Yellen “weak USD” pivot / “Shanghai Accord” in ’16 and the Powell capitulation in Jan ’19 after the QT on “auto-pilot” / “long way from neutral” financial conditions tightening tantrum).
McElligott explains that last week’s violent action de facto evidenced a sense that the “Fed Put” has been (at least temporarily) re-struck lower:
…the aforementioned “trapped positioning” being netted- or grossed- down into year-end risk mitigation and illiquidity, as the Fed is now viewed as unable to “bend the knee” to a market which is conditioned for a pivot towards a dovish accomodation;
…it seems increasingly clear that until CPI likely peaks in 1Q22 (as inflation is now a tier 1 “political hot potato” issue), the FOMC are unable to kick-save us ”easier”.
But, the Nomura strategist notes that the market is really hedged here, pricing in “crash” at eye-watering levels across major US indices…
…and that could dictate a monster rally, as long as spot can hold north of 4500 and things don’t crack this week… if possible, holding until options expiry the following Friday (Dec 17th).
SpotGamma notes that there are currently 3.3 million SPX puts tied to 12/17 expiration and if selling picks up we see a reflexive negative gamma feedback loop, explained here. Essentially a break of 4500 may indicate that realized volatility (i.e. actual S&P movement) will rise to meet current implied volatility.
But, McElligott warns, threats remain, including local proximity to SELL triggers in CTA Trend where both NQ and ES signals would go from “+100% Long” to “-40% Short” with real notional behind it on the “flip” long-to-short signal:
S&P 500, currently 100.0% long, [4531.25], selling under 4508.46 (-0.50%) to get to -40%, more selling under 3518.59 (-22.35%) to get to -100%, flip to short under 4508.46 (-0.50%), max short under 3518.59 (-22.35%)
NASDAQ 100, currently 100.0% long, [15723.5], selling under 15598.13 (-0.80%) to get to -40%, more selling under 11973.36 (-23.85%) to get to -100%, flip to short under 15598.13 (-0.80%), max short under 11973.36 (-23.85%)
Regarding VIX at 30, the Nomura strategist points out that the S&P really needs to sustainably move more than 1.5% a day (frankly closer to 1.8ish%), or else VIX is going to collapse under its own weight and mean-revert lower as it always does, thanks to reflexive Vol sellers (shorting “rich” vol as a buy-the-dip expression) and downside-hedge-monetizers (taking profits as a selloff realizes, both of which create Delta to buy).
But… if we keep realizing this 1.5%-2.0% area that is being implied, McElligott concludes ominously that there is still hell to rain down (read, lots more $ selling).
SpotGamma also warns that while they are giving an edge to a rally into next week – you must respect the downside. This is a market for large directional swings and not mean reversion. 12/17 expiration is 2 weeks out, and just ahead of that is a major FOMC meeting on 12/15. What comes from that FOMC will combine with an OPEX accelerant to make for a very interesting end to 2021.
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