“Normally” the post-September Op-Ex seasonal “should” see the S&P trade lower into month-end, but there’s a new wrinkle thanks to the psychology around the imminent expansion of the Fed’s balance sheet to alleviate reserve scarcity.
For weeks, Nomura’s Charlie McElligott suggested that US equities would trade up into mid-month, and then fade as a series of flow catalysts came off, and the forces keeping the index “pinned” near 3,000, rolled off.
However, last week’s acute funding squeeze introduced a new dynamic. Thanks to the schedule released on Friday, we now know the Fed is set to conduct overnight repos every day and there are a trio of 14-day term ops for good measure. By mid-month (i.e., when those term repos will need to be rolled lest markets should get spooked), the Fed will need to have pre-announced (for all intents and purposes anyway) organic balance sheet growth.
That’s a new macro catalyst, and it could change the game.
“Directionally in US stocks and after Friday’s options expiration, we have now unshackled with ~ 34% of the overall $Gamma across all strikes coming-off, in particular with the enormous ‘Long $Gamma’ which was pinning-us ~3000 in SPX for the past few weeks”, McElligott writes, in a Monday morning note, reminding you that “the ‘typical’ post- September Op-Ex seasonal then sees SPX trade meaningfully LOWER out over the next 1-2w, largely as the ‘demand flows’ from Overwriters and Corporates then disappear following Expiration and buyback blackout, respectively”.
But again, there’s a wrinkle – “QE-Lite”.
“However, the urgency of the $funding drama at the start of last week ‘shocked’ a new macro-catalyst in place to alter this seasonal ‘SPX LOWER’ flow, and instead, introduced an idiosyncratic ‘Fed policy escalation’ input to the mix”, Charlie continues, reiterating a point he made on multiple occasions last week.
It’s possible, he reckons, that market participants will overreact to any headline about “balance sheet expansion”, as even those who do understand the nuance and the rationale in the context of the funding squeeze (i.e., the “organic” bit) will still be unable to restrain themselves from chasing the “QE-Lite” story, if only on the assumption that others will be similarly inclined.
“In the post-GFC regime, the muscle memory for the majority of Equities investors has conditioned them to simply think ‘balance sheet expansion = QE’ and thus, risks a ‘BULLISH risk-asset sentiment shock'”, McElligott says.
Now that the extreme long gamma dynamic that was pinning the index has rolled off, it’s possible things can start to move in earnest.
On the upside, McElligott flags large $Gamma strikes at 3000 ($6.5B), 3025 ($5.1B), 3040 ($3.6B) and 3050 ($7.7B). When you consider that with under-positioning across funds, you’re left with a setup that “could drive ‘chase’ behavior as we approach Q4”, Charlie says.
And yet, the downside risks remain, particularly in the 2,935-2,945 region, where McElligott notes we could see “the convergence of three ‘accelerant flows’ as Gamma vs Spot flip level in SPX Futures is ~2936, Delta vs Spot would pivot @ ~2938 and Nomura’s QIS CTA model’s current deleveraging ‘sell trigger’ estimate for the SPX futures position is sitting below 2943”.
You can add to all of this what looks like the beginnings of another growth scare with egregious South Korea exports data overnight and eurozone PMIs clearly showing Germany is in a recession.
Oh, and then there’s the trade talks set for early next month.