I told you there would be volatility

Mid-week market update: I told you that there would be volatility (see Numerous wildcards add up to ST volatility). In light of signs of stretched positioning, the prudent course of action for traders is to step to the sidelines.



Here are the different sources of volatility that are buffeting the markets.



Quarterly refunding announcement

The Treasury’s  QRA used to be non-events, until recently when refunding announcements became key turning points in risk appetite. The market took a risk-on tone on Monday when the U.S. Treasury announced a smaller than expected Q1 issuance. Part II of QRA came this morning when Treasury announced the schedule of its offerings, which didn’t move markets as the split between bills and coupon bearing paper was more or less in line with expectations and didn’t significantly move the bond market. There was, however, some concern that the pace of bill issuance translated to sufficient liquidity that the tapering of QT would be delayed, which was a mild negative for risk assets.




The Fed decision

The Fed signaled that the hiking cycle is over and rate cuts are in sight, but the “Committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2 percent”. Consistent with speeches by Fed Governor Waller to push back against market expectations of a March rate cut, Powell effectively took a March cut off the table.


As a consequence, market expectations call for the first rate cut to begin in May. The Fed has shown it doesn’t like to surprise markets. If Fed officials don’t push back against a May cut in the coming days, then I would consider it to be the base case scenario for forecasting purposes.



Moreover, even though the S&P 500 took a risk-off tone during Powell’s press conference, I find it constructive that the 10-year yield managed to stay below 4% by the end of the day.



Earnings season

Arguably, the Magnificent Seven was going to have an outsized influence on the direction of the market during earnings season. Analysis from FactSet shows that the Magnificent Seven accounts for all of the expected earnings growth in Q4.



In addition, analysis from JPMorgan indicates that concentration risk is spiking, which makes swings in the Magnificent Seven far more significant to the direction of the S&P 500 than usual.



When Alphabet and Microsoft reported yesterday, both beat earnings and sales expectations. But they both sold off because of disappointment over AI-related growth expectations. Does this mean the AI mania has run its course? Not yet. I believe the best tactical indicator to watch are the semiconductor stocks, which remain in absolute and relative uptrends, but they are nearing the bottom of their rising channels. A breach of the uptrends would be signals for caution.



Even though I am not inclined to front run model readings, I am inclined to be somewhat cautious. The weekly chart of QQQ shows a shooting star candlestick, indicating a possible trend change. The shooting star needs to be confirmed by falling prices in the next candle, which seems to be the case, but the week isn’t over yet.



When I analyze the S&P 500 on a daily time frame, the upper Bollinger Band ride that the index was on seems to be over, indicating a loss of price momentum. However, it’s unclear whether this resolves in a brief sideways consolidation followed by another advance, or corrective behavior. In particular, the VIX Index is already near its upper Bollinger Band, which is a signal of an oversold market.



This week’s sources of volatility isn’t over. Amazon and Meta, both members of the Magnificent Seven, will report tomorrow after the close.



Friday morning will see the December Payroll Report. Brace yourself and stay tuned.