Hey There Income Hunter,
Jerome Powell must be feeling the heat.
This could impact his decision today as he chooses whether to double down on “pain” (and a recession) to get prices down … or down-shift and the rate rise.
This is crunch time as volatility in bonds remains at all-time highs, with 10-year bond interest rates hovering near 4%.
A Santa Claus rally in equities and bonds or a crash-and-burn into year’s end is hanging in the balance until today’s decision.
A research paper out of John Hopkins, with assistance from the International Monetary Fund, has tightened the vice grip on Powell a bit tighter …
The paper concluded that to bring Inflation down to 2%, the US would need unemployment to rise to 6.5% and remain there for two years (!).
The paper states that after two years, we may see 2% inflation … but 10.8 million people would be without jobs.
You can imagine how this went down at the White House …
Today, I’ll reveal what this means for the markets and the Fed.
Decisions, Decisions
Check out this statement from Senate Banking Committee Chair Sherrod Brown last month …
“I ask that you don’t forget your responsibility to promote maximum employment and that the decisions you make at the next FOMC meeting reflect your commitment to the dual mandate.”
I feel Powell’s pain, but let’s remember that we are in this situation because he chose to ignore inflation when it first broke above 2% to begin with.
If the Fed had followed the past approach of being proactive based on forecasts instead of being data dependent and backward looking, it would not be in such a tough spot today.
Although I’m profiting well with 17 wins in 21 closes in Power Income Trader.
Let’s Check the Numbers
The Fed Funds target range is currently 3% – 3.5%. As you can see below, the market is pricing in an 86.5% chance of a .75% rate hike.
That would bring the range to 3.75% – 4%. For the Dec. 13 meeting, notice in the table below that the market is still pricing in another .75% rate hike but barely as a .50% hike has a 44% probability.
I think the .50% or .75% hike in December is all that is on the table for discussion right now.
Notice the chart below showing the change in expectations just yesterday. The market reduced the terminal-rate expectation from near 5% to 4.90% and also lowered the rate for H2 2023 down to 4.75 …
Post FOMC Game Plan
The surprise will be what the Fed decided with the December hike. It is really a toss-up between .50% or .75% hike.
On a .50% hike, I think we get a rally. The graph below illustrates yesterday’s trade in SPY and notice the red oval around the 390 strikes. That strike is where SPY is in the balance between negative and positive gamma …
Above 390 positive gamma dominates, meaning option dealers are long gamma and will be sellers above the market and buyers below (Vol compression)…
Below 390 negative gamma takes over, meaning option dealers are short gamma and are sellers down and buyers up (Vol expansion) …
Also, notice the horizontal line within the oval… The blue side is the open interest in the 390 puts and the orange side is the open interest in the calls at the 390 strike.
Now, take a look at the red dotted line at the 395 strikes… This line represents the largest net positive gamma strike called the call wall and is strong resistance.
The bottom line is, if Powell only offers the market a chance for a .50% hike in December instead of .75% and SPY rallies up to 395, it is a high-probability sale at that level.
Bring It Home
My view for today is that the market will extend in whichever direction it goes post Powell’s remarks.
This is because the FOMC will initiate a feedback loop of higher or lower implied Vol, which will fuel dealer hedging flows that continue SPY higher or lower.
This trend should continue into the Nov. 18 options expiration date unless an external shock drives longer-term money flows.
The surprise to me heading into the FOMC over the past week was how low vol dipped.
This serves to expose the market to more of a violent downside reaction because of the lack of put protection below. So, if Powell remains extremely hawkish, then we could see an extended flush down to the 3600 area.
If you have longs this also tells you you are better off hedging before Powell’s speech and Q&A.
Call 1-888-872-3301 for full details and potential special offers and credits!
Until then …
Live and Trade With Passion My Friend,
Griff