Consolidation & low vol. Second leg?

Paid subscriber analysis

As we said on Wednesday, the FOMC didn’t deliver anything unexpected. In itself this was enough for a brief positive reaction from the markets on the day. We talked about volatility going down as a consequence - both before and after FOMC, which pushed markets up. This basically means that we hit a local bottom last week at 5,500 for SPX. However, even though VIX ended this week below 20 again, SPX couldn’t push above 5,700 - and it tried twice. It kept trading within the 5,600 - 5,700 band for the entire week.

So was all this just a temporary relief rally driven primarily by declining vol before we get another leg down?

Quite possibly.

Today we examine some technical implications of these moves, and discuss potential paths in the weeks ahead.

Clearly, SPX was in consolidation mode this entire week, driven primarily by declining volatility. The VIX going down opened up some room for a market rally, but it never really delivered, not nearly as expected.

This was our prediction from last Saturday:

They [FED] could provide an additional boost to the unclench of vanna and charm flows, bringing the VIX down below 20, and set the stage for a medium term rally.

The most likely outcome is: vol compression continues, we get a relief rally next week. It probably won’t be anything too aggressive.

VIX did go below 20, we did get a relief rally, and it wasn’t aggressive at all. It was timid. This means there’s still great uncertainty out there and that we are getting closer to a breaking point. The consolidation with declining vol could last for another week or two, it’s very hard to tell exactly.

But all this smells like a set-up for another sell, below the previous low of 5,500.

There’s two potential scenarios here.