Although last week’s rate cut was widely anticipated, the Fed surprised the majority of economists with a 50bp rate cut, reiterating its commitment to not keeping policy overly restrictive for too long given the deteriorating labour market. Historically 50bp cuts followed “crisis” events, and this year’s-round appears to be more of a proactive response by the FED, with the main purpose avoiding a policy mistake and a hard landing. On the back of the rate cut, the SPY broke above its prior all-time high resistance with improving breadth among major US indices, while European indices remained relatively muted on the back of weak PMIs.
Following the selloff in the first week of September and heading into the Fed decision, market gamma was negative to the upside on the back of high demand for upside delta via calls rather than spot, reflecting increased uncertainty surrounding the Fed decision, which has partially contributed to the melt up over the last few trading sessions. Market gamma is now positive after last Friday’s September OPEX, the largest 3Q expiration on record, which will serve as a dampening effect on volatility and a potential pause to big upside moves in the short term. However, entering 4Q and ahead of the US elections, volatility remains unusually low.
In term of positioning, we see several conflicting forces. The Hedge Fund cohort has continued its net selling of US equities with the sectors most sold being Consumer Discretionary, Utilities, Energy, Materials and Staples, while Tech, Communications and Financials sectors have been net bought. The ongoing corporate buyback blackout expected to last until the last week of October also acts as negative pressure on equities, while on the flip side, long-only institutional buying has served as an offsetting force to Hedge Fund selling, with the cohorts positioning in the SP500 at renewed all-time highs. Declining volatility has also been favourable for further positioning in equities by volatility control funds, which had reduced their positioning after the recent sell off. In addition, Money Market fund Assets have also decreased with expectations for an ongoing rotation into equities as the rate cut cycle progresses.
This week is anticipated to be more subdued in terms of data. On Friday 27 September, the US PCE will be released and while the previous print saw the index rise 2.6% YoY, we do not anticipate this to be a market-moving event, as inflation woes are softened by deflationary pressures out of China, and given that the market is now more focused on the strength of the underlying economy. As measured by SOFR rates, the market is now pricing in a 50/50 probability of a hard landing following the weak job report in August, and it now awaits the next US job data on 4 October. We expect market activity to remain muted until then.
Given the fast rebound to all-time highs and markets at c.1% above our entry levels we maintain our SPY Dec24 510 puts. In light of extended valuations, expectations of limited upside from current levels and higher volatility expectations for the remainder of the year, should the market rise higher we will look at buying into VIX calls.