“Sleepy” Fed expectations (no “dots” for Powell to have to explain away, which means the same effective conversation regarding tapering being “still a ways off” continues to apply) have tilted incrementally “dovish” in just the past two weeks alone, on account of the Delta variant hysteria raising concerns about more lockdowns and risks of global demand disruptions.
However, as Nomura’s Charlie McElligott warns, when one looks at the economic data progression since the June meeting, it paints a real risk of a “hawkish surprise” potential later today, even just as today likely lays the groundwork for the Fed’s September meeting to be the one where we see tangibly more “hawkish” Fed rates forecasts and confirmation that strategy discussions on tapering” are underway.
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Another upside surprise in the June headline and core CPI, but particularly in the key “persistent” inflation input “Shelter” category—which will pressure the Fed’s inflation fwds in standard lagging fashion, while strengthen the case for tapering of MBS QE (fwiw, June Pending Home Sales a +6SD surprise).
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June NFP was also an upside surprise (+1SD), with higher wages continuing steady; the fwd pipeline of job seekers is also expected to build in coming months as the last of the UE benefits run-out as well.
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June Retail Sales was a “beat” as well (ex autos and gas at +2 stan dev)—meaning demand remains strong (i.e. inflation is not simply a supply-chain “bottlenecks” issue).
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Critically too, “inflation” has become a political hot potato for the Biden administration (Bloomberg weekend piece “White House Shifts Messaging on Inflation as Republicans Attack”), which is already reeling from the inconsistent COVID messaging and now, the mess of the CDC mask policy reversal—so the political component is now increasingly a “silent voter” in the FOMC room.
In fact, as we detailed yesterday, a closer look at the volatility term structure reveals that the S&P options market has begun to price in meaningful event risk around the late-August Jackson Hole Economic Policy Symposium. This risk premium first appeared on 9-Jul following a local low in 10-year US Treasury yields below 1.3%, and has only widened in the last two weeks, suggesting that the S&P options market is trying to price in the risk of a hawkish turn by the Fed at Jackson Hole. This is to be expected: According to the latest BofA Fund Manager Survey, investors expect the Fed to announce a tapering of asset purchases either at Jackson Hole (Aug 26-28, with Powell likely to speak on the 26th) or at the Sep FOMC meeting (22-Sep).
The VIX market is also reflecting increasing concern around Jackson Hole, as seen from the historically wide gap between spot VIX and constant maturity VIX 1m futures and continues to embed a very robust convexity premium (Exhibit 14) to account for still-elevated fragility risk in US equities/equity vol.
Yet despite the market’s growing nervousness surrounding Jackson Hole, retail investors could care less as they anticipate positive seasonals after the J-Hole malarkey…
As McElligott slightly sarcastically noted: “SPX index option upside Call Skew continues to be nowhere, with absolutely negligible “crash-up” demand in SPX or QQQs… clients apparently just long a lot of $s of stocks at all-time highs, go figure.“
And while the S&P and Nasdaq remain “pretty sticky insulated” from any gamma-driven chaos, IWM (Russell 2000) remains source of “accelerant flow” risks, with Dealer “short gamma vs spot” (only flips positive up at 222.35 ref 218.85) with delta deeply negative too (flips up at 225.19 ref 218.85)—overall IWM $Gamma is -$370mm, 4.8%ile, while $Delta is -$10.9B and 5.4%ile
But, as we noted yesterday, we are sure that ‘accelerating’ weakness is likely be bought as that’s all the current crop of investment gurus know.
The strength of the buy-the-dip behavior is confirmed by the downward trend of the recovery periods, reaching a new all-time low this year.
The above is self-explanatory, and the only thing we can add is that in a centrally planned “market” where the Fed has effectively outlawed drawdowns, corrections and – heaven forbid – bear markets, the only trading strategy is being the first to buy the dip, any dip.
