Setting Free The Bear
Market Structure for Options Expiration into month and quarter-end is a mixed bag.
On the one hand, SpotGamma’s founder, Brent Kochuba, thinks;
“Ultimately this expiration is clearing out a lot of equity put protection, which clears the way for lower lows in the weeks and months ahead.”
But Nomura's McElligott isn't convinced. Since lots of short gamma is expiring on Friday, the "destabilization effect" becomes much smaller.
SPX / SPY expecting 42% of $Gamma to expire Friday
QQQ expecting 56% of $Gamma to expire Friday
IWM expecting 57% of $Gamma to expire Friday
HYG expecting 46% of $Gamma to expire Friday
I am often not wanting to take the other side of the trade with McElligott, but I still see $3400 SPX, so, I'm gonna go with 'something' is going to happen to destabilize the market and spike volatility with US dollar, yields and oil. Yeah, it's probably the oil spike that would increase in probability IF the market stabilizes! Ok, if that reverse psychology confuses you, please read my market thoughts yday where I posted my thesis either oil spikes with USD and Yields OR it pauses while market corrects lower. If market stabilizes/grinds higher, I am absolutely betting on an oil spike to stop it.
My thinking on oil now is that as long as equities correct/crash, oil won't go parabolic, yet. This does not mean that I am bearish oil or that I think my $160 crude oil won't materialize this summer (then higher into next year). I absolutely think it will. But not while equities are crashing. I can see a case for a lag. They will politely 'wait' until lower equities (SPX 3400) and then march higher. Or they just spike higher with USD + TNX + Gold. Either way, equities are in trouble.
Long Weekend Risk post FOMC Wednesday, Trump Indictment Potential Thursday, and Triple Witching OpEx Friday
I have been so focused on FOMC this week, that I had no idea of the potential DOJ indictment of former President Trump Thursday night. I also have no idea if this would be market-moving, but I do worry about civil unrest. Also, in case anyone forgot, U.S. Markets are closed on Monday, June 20 for Juneteenth National Independence Day, which makes the post OpEx Friday even more important to weekend risk hedging!
Add to all of the above and we have an event-filled, market backdrop this week that can create volatility in either direction, not the least of which is the macro headwinds that are turning hurricane strength:
US 2-year yields have spiked the most since 2008 and 10-year is above my 3.33% 'yield spike' threshold for much higher (4.5% this year).
FOMC decision is Wednesday and even though Powell has communicated a 50 bps increase repeatedly, WSJ and "the street", are intonating a 75 bps surprise, while JPMorgan is floating 100 bps chance.
USD is above my $105 'risk-off' threshold.
Oil YTD is up 62% and still threatening higher by a lot ($160 crude still my baseline bet this summer.)
Credit spreads are widening. In fact, CDX IG has hit 100bps for the first time since 2020, putting the 2s + 10s yield curve at basically 0.
In fact, just about every portion of the yield curve is inverted except 2/5s, 3m/2y. Bond market continues to implode and by my read, has much further to go.
Nasdaq is down over 30% with SPX at 20% drawdown and "capitulation low" isn't blurted out as often by market/media pundits as much anymore. We are just starting to climb the proverbial "wall of worry".
None of my #intermarket-tells has given any safe sign of 'swing long' entry. In fact, I have my cumulative volume and breadth indicators and stock-bond volatility tells screaming "AIR POCKET OF RISK".
I remain a bear on a Trend and Swing basis.
On a smaller timeframe, tomorrow could be a short-term Fed pivot for a short-term bounce or a complete collapse!
I posted this under #chase-ideas as I have had no interest in playing any countertrend longs in this market given the risk:reward:
Keep in mind, my flash crash warning is still in effect and a rising macro backdrop of higher US dollar, yields and oil is a solid headwind to equities. Nothing has changed in this regard, but a pullback in VIX to $29 area in the very short-term wouldn't surprise me and with that a wee market bounce.
I still don't trust this market as far as I can throw it, but with Fed expected to announce bigger-than-expected rate hike tomorrow (75 bps), we could get a market bounce on the perception that Fed is intent on actively fighting inflation, but then I will look for the re-short level (max 3994) as I still expect market to break down thru SPX 3760 on way to $3645, then 3588, to 3393 - this summer.
I reviewed much of my macro-to-micro thesis in my afternoon trading room session today, so I recommend checking that video out. I also uploaded a ton of my #intermarket-tells yday with market, sector and volatility inflection points including my full review of breadth destruction underlying this market pullback.
Tomorrow is FOMC at 2ET with Powell/Brainard press conference 2:30ET. I had a long-ago scheduled presentation to deliver 2-3ET for the Mad Hedge Fund Conference, so unfortunately I will not be opening the trading room early on FOMC day as usual. I will however open at 3ET to catch the end-of-day market reaction and position for rest of week into triple witching OpEx on Friday ahead of the long weekend!!
Over In Europe
Our #global-sector-rotations swing shorts in EZU, EWG, EEM, EWG continue to work exceptionally well with our swing short in EURUSD. And here's why - beyond the energy crisis and Russia-Ukraine war with all of its collateral damage in the EU: Market now expects that the ECB will raise rates to around +50 basis points this year, after just saying they were going to maintain negative rates through end of this year. That's a big pivot.
Another problem is that the ECB plans to tighten much slower than the Fed, and this helps to fuel inflation expectations and pull rates higher while putting pressure on the euro which continues to devalue against the dollar making commodities even more expensive for countries of the Eurozone because most everything is priced in dollars! Speaking of the Euro, I had a discussion with a colleague today who reminded me that IF Biden was to ever announce a US oil & gas export ban (which is a policy which would help lower US energy costs), the energy crisis in Europe would explode and its Euro implode. That's another really good reason for the inflation season to last longer than many expect.
Over In Japan
BOJ continues to hold its monetary policy loose by not joining in the rate hike party. Ironically, rising global rates are caused in part by BOJ policy to buy unlimited JPY bonds and keep their yield curve controlled. Moreover, these same rising global rates challenge the BOJ's efforts to cap the 10-year yield which they have set, resulting in a 20+ yr low in the yen (and still doesn't look done falling).
Here's the irony: As the BOJ continues to buy an increased (endless) amount of (printed) bonds and expand its (fiscally unsound) balance sheets, this very action adds to the die-vergence that is driving the USDJPY higher, pulling up US yields (which are now approaching parabolic levels), which then creates the destabilization of markets! BOJ and Fed policies have often been cited as crazy, but now they are plain reckless albeit trapped.
This closed-circuit of bond buying which is fueling inflation and helping to drive global rates higher isn't a BOJ or Fed phenomenon, but it is the reason that Emerging Market FX currency markets are panicking and bleeding into both bond and equity volatility. With that, USDJPY holding > $135.50 on the weekly chart will be gnashing of teeth in that it will continue to force the selling of US Treasuries, in trade for USD, thus lifting US yields to a point that will break things. The 10-yr (TNX) is already above my line-in-sand 3.33% level of "hold onto your hats, it's gonna be a bumpy ride!"
The bigger issue will come later: Devaluing a currency "into prosperity" has never worked in the history of the world, but this is a release valve to prop up the bond market and with it economy. At some point, governments must choose between them I fear - about when they are forced to choose between buying PAPER bonds or THINGS people desperately need, like energy and food.
Until then, as long as energy in purchased mostly in USDs, and while both dollars and energy costs continue to rise with yields, developed markets will stay unstable and emerging markets will risk collapse.
Pre-FOMC Final Thoughts
Jon Turek sums it up best I think:
This may have been the most chaotic market pricing into a Fed hike in two decades. Since the May CPI print (Friday), markets have priced more than 75 additional basis points of rate hikes for this year and have taken the terminal rate of this hiking cycle to just over 4%. Just eye popping moves in such a short period of time. And then of course there was yesterday, where 20 hours before a an FOMC meeting an article drops from Nick Timiraos (the number one Fed reporter) that the Fed is considering hiking 75bps at the June meeting this week. This locked in a 75bp hike for this week and likely will lock in another 75bp hike at the July meeting.
Keep in mind, back in Nov of 2021, the terminal rate of this hiking cycle was 2%. It's doubled!!! Now traders see 200 basis points of tightening by September. No wonder the bond market turmoil continues with liquidity worse than it was leading up to Lehman I've heard reported. And that creates even more risk because if the market doesn’t have liquidity, it can gap down very quickly.
Me to clients, May 10th:
My rate-of-change analysis reads Fed + inflation are both unanchored.
Yields will move much higher as bonds sell off.
What normally takes yrs to unwind will now take months as bonds are stocks without circuit breakers.
And again May 27th:
Inflation and Fed Fund Rate spread has never been wider.
For emphasis:
Being bullish risk equities is fighting the Fed
As a risk manager - which we all are - we want to be buying into liquidity not dangerously-thin liquidity and margin calls that can create panic selling. And the MOVE index of treasury volatility is now approaching Covid Crash highs with VIX still under 36. Color me skeptical, but a 75 bps rate hike or even 100 is not going to remedy the systemic problems that are creating the systemic risk.
