Is it time for a cascading stock selloff?
Maybe. Thursday’s bear steepening in the US curve looked pretty onerous, and markets were in the process of paring back expectations for Fed cuts in 2024 consistent with the new dots. Spot equities looked shaky.
Stocks were dangerously close (and indeed through) key levels associated with dealer hedging flows and systematic de-leveraging.
“Rates continued to trade heavy into [Thursday], with the entire SOFR curve experiencing a parallel shift meaningfully lower and reds and greens making new lows, as the distribution of implied Fed cuts are pushed further out [while] both nominal and real yields make fresh cycle highs,” Nomura’s Charlie McElligott wrote, flagging a “cluster” (I’ll leave the obvious joke unstated) of proximate, potential equities “downside accelerant flows.”
As tipped here on Wednesday, a break below 4,400 SPX would shove dealers into short gamma territory. That’d set up the dreaded “selling begets more selling” dynamic.
Recall that one reason that dynamic is so pernicious is that it can drive spot equities through levels associated with CTA triggers.
Sure enough, Charlie said CTAs would be sellers through 4,409, where the bank’s model suggests the signal for momentum chasing robots would go from 88% Long “all the way” down to 38% short. The estimated futures selling would exceed $12 billion.
Meanwhile, things could get uncomfortable for VIX dealers (in options) “north of 17 and 20 strikes,” McElligott noted.
Ultimately, it hangs on whether opportunistic vol sellers see this as yet another opportunity, or whether the fear of “higher for longer” is enough to dislodge the Pavlovian response function.
“At the end of the day, the key to undermining the above mechanical market dynamics and their potential to exacerbate a selloff will come down to the willingness of vol sellers, either monetizing hedges or exploiting VRP, to push back on the spot move lower” by unwinding downside hedges and selling puts, McElligott said.
Many years ago after our daughter was old enough to be left alone, my wife and I got back to golf. We weren’t as good as we once were so we went to golf school for a week. Two of our fellow students were personable young men who worked as the trading managers for the Bank of Canada’s short-term treasury and FX portfolios. They actually worked in NY and were taking a pre-season vacay to tune up their games. They were both 32 with nearly snow white hair, a side-effect, they said, of being traders. I look at the activities described in this post and I can’t even imagine what big time CTAs cope with today on a daily basis. What a way to make a living.
I had an all to brief reunion with an FX trading desk co-manager from the mid 1980s. He remarked how computer trading system have totally replaced us all.
Today’s wimp CTAs just tend to their models, under strict instructions not to take any initiative counter to what the models signal
…on the bright side, if today’s action becomes the short to intermediate term trend we should see kinder gentler December FOMC dots, as opposed to today’s “Revenge of the Killer Dots” attack…
I take most market mantra and indicators with an (un)healthy dose of salt, but seasonality I respect, it almost always bites this time of the year.
So, if we all know how markets work today, then can’t a group of CTA’s or VOL sellers get together and manipulate the markets in the other direction? Of course, who could imagine such a thing happening. Momo begets momo in whatever direction despite whatever logic says should be happening.