FOMC and OpEx week 🚀🎇💥

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This week was one of those where the market was trying to find its footing. Are we bearish or are we bullish? It started jumpy on Monday and Tuesday, and then a strong sell on Wed open, after getting the CPI inflation data which came in as expected (inflation is now down to 2.5%).

The bears tried to push a sell-off on Wednesday open, but it never broke below the 5,400 level; the support established last Friday (see chart). It tapped it on Wed, but didn’t follow through. On the contrary, it bounced back strongly on Wed (from -1.5% to +1%), and continued rallying for the rest of the week (ending the week +4%).

This is pretty much what we labelled as potential scenario #1 last week:

Markets rally into Vixperation, and into the Fed meeting. If they are at 5,650 or 5,700, then a supportive Fed (and especially supportive dot-plots) will compress volatility, and markets will squeeze up, setting up a rally for the rest of the year.

If we don’t get a crash soon - pushing below August 5th lows, the odds of which are decreasing as every day passes - volatility will get decimated and send markets up sharply. That’s when the supportive flows do their magic.

However, if we do sell-off into the August lows, then the market is front-running the Fed due to poor economic data, the Fed cuts 50bps due to recession fears, and we get a proper sell-off. This scenario is less likely than the one described above, because the data is unlikely to deteriorate so much that we start pricing in a recession. The bigger danger, in my opinion, won’t come until after the FOMC on the 18th.

SPX is going for that 5,650. The implication stays the same. We are rallying into FOMC, where a supportive Fed very likely causes another squeeze.

Therefore, the odds are shifting in favor of the squeeze post-FOMC, but please do be on alert as anything can happen during FOMC weeks. Particularly as we get an updated dot-plot chart.

So today, let’s look at what might happen.

First, the expectations. At the end of the week, the odds for a 25bps or 50bps cut are literally a coin toss:

However, look at the dynamics. The odds for a 50bps cut went up from around 30% to 50% this week. Why? Well, apparently the Fed leaked to WSJ journalist Nick Timiraos (as they often do, allegedly) that they are seriously considering a 50bps cut. They are said to do this sometimes in the week prior to an FOMC meeting to see how the markets might react. Even though this is mostly hearsay, the reaction was obvious, and probabilities adjusted quickly.

Furthermore, markets are now pricing in 125bps in cuts until the end of the year, meaning 50bps in at least two of the three remaining FOMC meetings. So pretty close to the expectations of 6 cuts we started the year with. Even though the Fed always said they were only going for 3 cuts.

This is why at the meeting on Wed, all eyes will be on the new dot-plot chart.