The Stock Market Could See A Sharp Pullback This Week
by Michael Kramer The Stock Market Could See A Sharp Pullback This Week
September 22, 2024
This week will be relatively quiet in terms of economic data. The main events are Treasury auctions for 2-, 5-, and 7-year notes, scheduled around 1 PM Tuesday, Wednesday, and Thursday. Other than a few Fed speakers and limited economic releases, the market will likely reveal its true reaction to the Fed’s recent rate decision.
These days, it’s harder to get a clear sense of market direction in the immediate aftermath of a Fed decision, mainly because there’s so much noise around implied volatility and bond market positioning. Unfortunately, that initial knee-jerk reaction takes a few days to settle.
Implied volatility affects everything, and a similar pattern plays out across different assets. The chart below shows implied volatility in 2-year Treasury Futures, USD/JPY, and the S&P 500. Everything dropped at 2 PM ET following the Fed announcement, but it wasn’t until the end of the day on Friday that the market fully absorbed the news, mainly because the BOJ meeting also carried significant weight.
Implied volatility resets and market bets on both sides have made the unwinding process confusing. However, I believe that the noise will clear up this week. Additionally, last Friday’s options expiration, with the big gamma level at 5,700, was too strong for the equity market to trade freely.
This explains why the S&P 500 hovered around 5,700 during the last two trading days. It formed a diamond pattern, on top of the “hole-in-the-wall” gap that opened Thursday morning. This suggests we may fill that gap early this week, potentially seeing the index give back the post-Fed meeting gains and drop back toward 5,615.
Short sale volume in the SPY ETF was also unusually high on both Thursday and Friday and on a rolling 10-day basis, it has reached its highest level since mid-March.
An interesting observation is that increasing short-sale volumes on a rolling 10-day basis can sometimes precede market downturns. This trend becomes particularly evident when inverted and compared with the price action of the S&P 500. Last Thursday and Friday, short sellers appeared to be aggressively establishing new positions
The same case can also be made for the QQQ ETF, which has seen short-sale volume pick up.
This, of course, coincides with a sharp drop in reserve balances last week. More recently, it seems that the S&P 500 is trading with a few days lag relative to changes in reserves. The steep drop in reserves wasn’t felt as strongly in June, likely given the offset in additional funding from the yen carry trade. But given the carnage in the Yen carry trade, those funding effects will likely be significantly diminished. If the Yen carry trade effects have been neutralized, and the S&P 500 is trading with a lag to reserves, we should feel those effects this week. If those effects are not felt, perhaps reserve balances do not matter anymore. However, I sense that they still do.
