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What Happened
Overnight, equity index futures resolved a multi-day consolidation and auctioned higher, far beyond the prior day’s range. Commodities were mixed while bonds were lower.
The break from consolidation is one of the most bullish happenings in weeks. We’re monitoring whether participants add to their recent short volatility bets against direction, or whether there is repositioning and this bolsters the initiative probe.
Ahead is data on University of Michigan consumer sentiment, inflation expectations, and new home sales (10:00 AM ET), as well as some Fed speak (7:30 AM and 4:00 PM ET).
What To Expect
Fundamental: To start, I want to apologize for any confusion, yesterday, with respect to the /GE Eurodollar quote. This newsletter said the peak of the Fed-rate-hike cycle – terminal rate – sat near December 2023.
That’s wrong. It’s December 2022.
Okay, moving on, now!
New data is pointing to a “remarkable” drop in demand for goods and services during June, compared to months prior.
“US economic growth has slowed sharply in June, with deteriorating forward-looking indicators setting the scene for an economic contraction in the third quarter,” S&P Global (NYSE: SPGI) Market Intelligence’s Chris Williamson explained.
“The survey data are consistent with the economy expanding at an annualized rate of less than 1% in June, with the goods-producing sector already in decline and the vast service sector slowing sharply.”
Businesses (particularly in retail) are way “more concerned about the outlook” of costs and demand, as well as the path in monetary policies and deterioration in financial conditions.
That’s validated by Tesla Inc’s (NASDAQ: TSLA) CEO Elon Musk speaking about the carmaker’s losses from new plants, supply chain problems, and the like.
“The past two years have been an absolute nightmare of supply chain interruptions, one thing after another,” Musk said.
“We’re not out of it yet. That’s overwhelmingly our concern is how do we keep the factories operating so we can pay people and not go bankrupt.”
It’s a global move into recession all at once, as Jeffrey Snider of Alhambra Investments says.
Read: Daily Brief for May 18, 2022.
“Combine the potential for break in repo collateral with economy heading toward recession, no wonder the Euro[dollar] curve inversion is spreading as rapidly as it has. Possibility of something big going wrong, therefore ending rate hikes, is huge now.”
“Euro[dollar] squeeze, collateral shortage, deflationary potential in money, and now demand destruction in global real economy.”
Over the last four decades, monetary policy was a go-to for supporting the economy. Money was sent to capital and that promoted innovation and, by that token, deflation, ultimately creating “unimportance to cash flows,” as well put by Kai Volatility’s Cem Karsan.
Now, there’s a strong commitment to reducing liquidity and credit, all the while there are chokepoints monetary policymakers have little control over.
This has consequences on the real economy and asset prices, accordingly, which rose and kept deflationary pressures at bay. A stock market drop is both a recession and a direct reflection of the unwind of carry. It is the manifestation of a deflationary shock, and today’s poor sentiments and economic data reflects this.
At the same time, “bonds are not acting as a hedge and appear to be becoming less ‘money’ like due persistent declines in price and elevated rate vol,” as Joseph Wang puts it.
Bank deposits are to drain about $1 trillion or so by year-end, prompting investors to “continue to lower their selling prices to compete for the cash they want.”
Retail buyers, who, according to Michael Wang of Prometheus Alternative Investments, “were a significant driver of the inflated valuations we saw in tech and crypto,” are capitulating in stocks, all the while froth in housing markets is soon to abate, likewise.
Notwithstanding, Mark Zandi of Moody’s Corporation (NYSE: MCO) does not see “the kind of mortgage defaults and distressed sales that would be necessary for big declines in housing values,” just as prices of raw materials are retreating as inventories are bloating.
As put forth, partially, earlier this week, one has to wonder about the likelihood that inflation is near its high and whether the de-rates have played their course.
Let’s keep an open mind and follow up on this, in detail, next week.
Positioning: Keeping this section short.
As stated yesterday, a feature of the equity sell-off is the suppression of implied volatility (IVOL) versus that which the market realizes (RVOL) given that participants are hedged and volatility remains in strong supply.
Read: Daily Brief for June 23, 2022.
Options data and insights platform SqueezeMetrics explained that this is due in part to lower leverage, too.
“Leveraged long S&P lost favor (understandable), and marginal demand for puts went with it. Creeping into net selling territory is ‘smart’ bear market positioning. Short delta, short skew.”
As I said in SpotGamma’s note, last night, given “the high starting point in IVOL, as well as its place in relation to [RVOL], it makes sense to own structures that benefit either from sharp changes in underlying price or an abrupt repricing in volatility.”
Cutting into the realization of a sharp change in underlying price or a far-reaching rally, however, are short-volatility bets across shorter maturity periods (and the associated hedging), as well as big (and popularized) positions set to roll off at the quarter-end.
Liquidity providers, per SpotGamma, all else equal, will have to sell to re-hedge, and we will talk about this further, next week.
Technical: As of 6:40 AM ET, Friday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, will likely open in the upper part of a positively skewed overnight inventory, outside of prior-range and -value, suggesting a potential for immediate directional opportunity.
In the best case, the S&P 500 trades higher; activity above the $3,821.50 LVNode puts in play the $3,843.00 RTH High. Initiative trade beyond the RTH High could reach as high as the $3,911.00 VPOC and $3,943.25 HVNode, or higher.
In the worst case, the S&P 500 trades lower; activity below the $3,821.50 LVNode puts in play the $3,793.25 ledge. Initiative trade beyond the ledge could reach as low as the $3,770.75 HVNode and $3,735.75 HVNode, or lower.
Click here to load today’s key levels into the web-based TradingView charting platform. Note that all levels are derived using the 65-minute timeframe. New links are produced, daily.
Considerations: Recent trade has been lackluster and the overnight break is the most bullish happening in weeks. The go-to trade this week was short volatility. Participants responded to tests of key visual areas, and sold options, particularly in shorter maturities.
In the coming session(s), some of those participants will respond to the break in a manner that bolsters the initiative drive. Notwithstanding, the key to watch for is whether participants will use the bump as an opportunity to add to their most recent short volatility bets against the direction.
Ultimately, the more time that is spent outside of the prior consolidation area, the likelihood that the breakout is a signal to look for dips to buy and play rotations to key areas up above.
Definitions
Volume Areas: A structurally sound market will build on areas of high volume (HVNodes). Should the market trend for long periods of time, it will lack sound structure, identified as low volume areas (LVNodes). LVNodes denote directional conviction and ought to offer support on any test.
If participants were to auction and find acceptance into areas of prior low volume (LVNodes), then future discovery ought to be volatile and quick as participants look to HVNodes for favorable entry or exit.
POCs: POCs are valuable as they denote areas where two-sided trade was most prevalent in a prior day session. Participants will respond to future tests of value as they offer favorable entry and exit.
Balance-Break + Gap Scenarios: A change in the market (i.e., the transition from two-time frame trade, or balance, to one-time frame trade, or trend) is occurring.
Monitor for acceptance (i.e., more than 1-hour of trade) outside of the balance area.
Leaving value behind on a gap-fill or failing to fill a gap (i.e., remaining outside of the prior session’s range) is a go-with indicator.
Rejection (i.e., return inside of balance) portends a move to the opposite end of the balance.
About
After years of self-education, strategy development, mentorship, and trial-and-error, Renato Leonard Capelj began trading full-time and founded Physik Invest to detail his methods, research, and performance in the markets.
Capelj also develops insights around impactful options market dynamics at SpotGamma and is a Benzinga reporter.
Some of his works include conversations with ARK Invest’s Catherine Wood, investors Kevin O’Leary and John Chambers, FTX’s Sam Bankman-Fried, Kai Volatility’s Cem Karsan, The Ambrus Group’s Kris Sidial, among many others.
Disclaimer
In no way should the materials herein be construed as advice. Derivatives carry a substantial risk of loss. All content is for informational purposes only.
