In case you missed it, stock and bond traders have spent the last five days still in the grip of an event that may be hard to remember for those fascinated by the Collapse of FTX.com: November 10 inflation report, which sparked short pressure among traders expecting a worse figure. The repercussions continued to be felt in terms of positioning, derivatives trading and probably also on ill-prepared portfolios.
As usual in 2022, the biggest impact has been the US stock options market, where trading volumes are at record highs as investors of all stripes rush into short-term contracts to catch up. This creates challenges for what had been billed as the great inflation trade, with the mighty dollar losing its luster and tech stocks regaining their long-lost leadership, at least briefly.
The recalibration was triggered when a subdued print on consumer prices triggered a reset in the perceived path of the Federal Reserve’s monetary policy. This phenomenon is exacerbated by fund managers who had reduced their equity exposure during the bear market and found themselves caught off guard. With almost everyone sitting on the same side of the trade and exiting at the same time, an already turbulent market just got weirder.
“Crypto is just one part of a larger mosaic of an almost dysfunctional market,” Doug Fincher, hedge fund manager at Ionic Capital Management, said over the phone. “Not to be cynical, but look at the CPI last Thursday. It was two basis points better than expected and the market exploded. There is a lot of rotation of technical factors. There’s just a lot of cross-currents in a really volatile and weird market.
The trend eased a bit during the week, with the S&P 500 closing lower for the period. Short-term Treasury yields regained ground and the dollar edged higher as Fed officials reiterated their intention to continue raising rates.
Whether inflation peaked is a matter of debate. There won’t be another reading for more than three weeks, and investors and policymakers have misjudged price trends since the pandemic hit. With data mostly ahead of expectations this year, everyone from currency traders to bond investors were bracing for another big inflation figure last week.
When that didn’t pan out, a cascade of unwinding ensued. The dollar, the darling asset of the inflation trade, is losing momentum. Down more than 4% in November, the US currency is about to experience its worst month in two years. Two-year Treasuries, where big speculators built record short positions ahead of the CPI report, staged a rally that pushed yields down 25 basis points on its release, the highest since more than a decade.
Tech stocks, among the biggest casualties of the Fed’s aggressive inflation-fighting campaign, got a break. Up more than 9% since the day before CPI data, the industry has beaten every other major group in the S&P 500, in a partial reversal of dismal returns earlier this year.
“These things are definitely going to happen at critical times in economic and monetary policy, where we are – the Fed going from raising rates to decelerating in terms of hikes,” said Layla Royer, a senior derivatives salesman. shares at
Securities. “It’s a significant change.”
A basket of top-selling stocks soared 18% in the four days to Tuesday, dealing another blow to hedge funds that boosted bearish bets during a 10-month rout and turned them into forced buyers. Their total short cover on the stretch has reached levels not seen since the retail squeeze in January 2021, according to data compiled by leading broker JPMorgan Chase & Co.
For the third time this year, the S&P 500 recorded a recovery of more than 10%. These countertrend rallies have spurred demand for bullish call options from those who have been defensively positioned in the market. As a result, the index’s bias – the relative cost of puts versus calls – fell this month to the lowest level in more than a decade.
“The market is screaming back. You risk losing your job because you are going to underperform everyone,” said Dennis Davitt, founder of Millbank Dartmoor Portsmouth LLC, an investment firm specializing in volatility strategies. “So the remedy for that is to just turn some of your stocks into cash and then buy bullish calls instead of stocks.”
Fed-induced market swings encourage investors to go all-in on options to place bullish and bearish bets. About 46 million contracts changed hands every day in November, on track for the busiest month on record, according to data compiled by Bloomberg.
The frenzy of derivatives trading maturing within 24 hours is helping fuel the boom. Those contracts accounted for 44% of S&P 500 options volume last month, according to an estimate by Goldman Sachs Group Inc.
For now, the fireworks following the CPI shock seem to be extinguished. The S&P 500 has moved less than 1% for six straight sessions on a closing basis, the longest period of calm since January.
For Mike Bailey, director of research at FBB Capital Partners, the tranquility may not last. On the one hand, the multi-asset rally has helped ease financial conditions, which runs counter to Fed Chairman Jerome Powell’s goal of slowing the economy.
“We may have some buyer’s remorse over the next few weeks as investors worry about a potentially hot jobs number and any whiff of hawkishness from Powell and the Fed,” Bailey said. “Investors are catching their breath after a great run since mid-October. The next question is: are we evaluating too much good news? »