Markets have experienced a challenging start to the second quarter, highlighted by the S&P 500's biggest weekly drop in three months and a substantial rise in US 30-year treasury yields, posting their highest increase since October. A notable driver behind the market downturn was escalating geopolitical tensions in the Middle East, which contributed to Brent crude oil prices climbing for the fourth consecutive week above USD90/bbl, heightening inflation concerns leading investors to scale back their expectations for rate cuts by the FED. A stronger US jobs report also added to the recalibration of rate expectations, and while the Fed may stick with a June start, the ongoing strength in underlying data could limit the magnitude of rate cuts, causing the market to price in a higher terminal rate. Only 63bp of rate cuts are now priced in by December, compared to 140bp expected at the start of the year, with ever-decreasing rate cut expectations putting the brakes on the market’s upward momentum.
In terms of positioning, CTA length in the SP500 continues in the 100th percentile, while discretionary players currently have the highest positioning in equities over the last 12 months. At the same time, hedge funds have seen the highest shorting of single stocks since the start of the year with consumer discretionary, which was one of the favourite sectors at the start of the year, ending up as one of the worst performing and the most net sold sectors over the last few weeks. In addition, a notable pair trade since the market rebound in 4Q23 has been shorting Energy stocks to fund Tech stock longs, and despite last week’s surge in oil prices, hedge funds continued adding to energy shorts, exacerbating the downside risk from having to reverse the pair trade, given Tech stocks have been the driving force behind the market’s recent rise. Gamma levels have also decreased significantly following the sell off, adding to the potential risks of bigger moves to the downside while liquidity impulse reflected in US reserve balances with the FED has reversed downwards over the last few weeks.
The highlight this week turns to the CPI report of on Wednesday 10 April, as core CPI has proven sticker than expected, with both January and February prints coming in hot, with the elevated energy prices in 1Q24 posing risks for a third hot CPI print in a row. Given the ongoing risks to the downside, stretched technicals, weakening liquidity and the markets at broadly similar levels as our 12 February note, A not-so-big-short, we propose June 24 390 puts on QQQ costing 0.52% of spot.