In the lead-up to the September FOMC meeting, professional investors polled for BofA’s monthly fund manager survey expressed a lot of faith in a soft landing. At the same time, they identified a US recession — i.e., a hard landing — as the top tail risk.
There’s some cognitive dissonance there, but it makes sense. The data — or the US data, anyway — does appear to favor a reasonably benign outcome to the most vexing macro conjuncture since Lehman and before that since the Great Inflation. But the early-August growth scare and the post-Labor Day aftershock were a reminder that the market’s still very sensitive to downside macro surprises, and STIRs still prone to pricing a fatter left-tail when given an excuse. Hence BofA’s description of fund managers as “nervous bulls.”
In the context of all that, the Fed’s decision to cut 50bps this week in order to preempt additional labor market weakness accomplished two things: It further increased the odds of a soft landing (i.e., the right-tail outcome) and rendered the odds of a hard landing (i.e., the left-tail) negligible.
Or at least that’s how equities were inclined, and in some respects forced, to trade the meeting on Thursday, when Wall Street powered to new records. Amid the fireworks, Nomura’s Charlie McElligott documented the dynamics, which is to say the macro-policy-market-flows nexus.
“Yesterday’s 50bps ‘lift-off cut’ blasted the market-implied probability distribution away from ‘hard landing’ and back into ‘soft landing’ mode [which] in turn is likely to send a defensively-positioned, de-risked, netted-down equities set across mutual funds, long/short hedge funds and systematics… into ‘grab and chase’ upside FOMO,” McElligott wrote, noting that the rally has now seen spot blowing through overwriters’ short call strikes, reminiscent of last year’s melt-up mechanics.
Moreover, spot equities made it into the “upside vacuum” region Charlie’s been on about for weeks. Dealers were short long upside optionality to clients — i.e., customer calls bought for “stock replacement” purposes — up above SPX 5640. As spot moved through that region, dealer hedging “creat[ed] a huge positive delta impact as market makers grabb[ed] S&P futures the higher they [went]” McElligott said, before putting some numbers to a few key anticipated second-order flows.
“As I’ve made a career of discussing, it’s the second-order flow impacts of these macro shifts which then create the market ripples,” he said, noting that Nomura’s pre-market September 19 projections tipped nearly $11 billion of EOD leveraged ETF-buying across the products the bank tracks, alongside $8 billion of projected Nasdaq 100 futures buying from the large, well-known big-tech overwrite ETF, whose short calls were, as Charlie noted, “deep ITM.”
In other words: Thursday’s early gains on Wall Street set the stage for as much as $20 billion of buy flows on the end-of-day rebalance, and that was on top of any simultaneous FOMO-buying from discretionary investors desperate to jump aboard a moving train.
