Is the Market Already Pricing in Goldilocks?

By:

Chief Strategist at Interactive Brokers

Last week we wrote the following:

There is reason for bulls, or at least dip-buyers, to eye next week’s FOMC announcement.”

My question for today is whether traders have gotten ahead of themselves yesterday and this morning in pricing in a bounce.

We have previously commented at length about Chair Powell’s ability to say what the market wants to hear, even going so far as to call him “Goldilocks in a Suit.”  He has already telegraphed a 25 basis point rate hike for this afternoon.  Given his disdain for negative market surprises, it seems highly unlikely that we will not get that move.  Thus it is already being discounted by investors.  As with many Fed meetings, the real action is likely to occur during and after the post-statement press conference, when traders have time to digest the “dot plot” of future rate estimates and after the Chair answers unscripted questions for about an hour.

Faithful readers will recognize the following table, which shows the performance of the S&P 500 Index (SPX) over the three-day period that encompassed the day of an FOMC meeting and the two subsequent trading days from the onset of the Covid-related stimulus to the most recent meeting.   We note that SPX closed lower two days after a Fed meeting 10 of 12 times from March 2020 through July 2021, a period when the Fed was relentlessly accommodative and markets were steadily rallying.  Since September, when the Fed’s stance (if not their actions) turned more hawkish, we have seen 4 of 5 higher closes.

3 Day Changes after Previous FOMC Meetings, Close of Prior Day through 2 Days After Announcement

It is important to note that the only time of the past five that we failed to rally was in December 2021.  That happens to have been the last time that an FOMC meeting preceded a quarterly expiration.  This Friday is also a quarterly expiration. We have seen SPX close lower all five prior times that the two have coincided (in bold).  We will know on Friday afternoon whether this streak will be broken.

It is important to consider as well that the maximum upward move in the table is 2.33%.  That occurred in September 2021, when investors were beginning to wrestle with the possibility of a change to the accommodative policies that had been in place for the prior year and a half.  Traders were enthused when it became evident that the policy change at that time was mostly rhetorical, with actual moves not likely to begin in earnest at least until the next meeting. 

Now the meetings are indeed likely to begin in earnest today, and we see SPX up nearly 3.5% since Monday’s close.  It is one thing to acknowledge that markets have already discounted today’s expected rate hike announcement.  It is another to consider that we have potentially made our largest upward FOMC-related move even before Chair Powell says a word.  The following chart shows the stunning change in sentiment over the past two days, as evidence by the VIX futures curve:

VIX Futures Curves – Today (green), Yesterday (orange), Monday (red), Last Week (blue)

VIX Futures Curves – Today (green), Yesterday (orange), Monday (red), Last Week (blue)

Source: Bloomberg

We not only see significant drop in the VIX Index (spot), we see that the curve has reverted back to something resembling contango (full contango would see the whole curve rising from left to right).  Last month we acknowledged that an inverted VIX curve was a necessary, but not sufficient condition required for a turning point in the recent sell off.   The curve never achieved the level of backwardation necessary to demonstrate the sort of true panic that typically marks major market bottoms.  Those typically occur when VIX sustains levels above 40.  Instead, we now see a relatively sanguine volatility structure returning immediately ahead of an event with a reasonable likelihood of inducing more volatility.

We’ve all heard the adage, “buy the rumor, sell the news.”  With markets rallying strongly ahead of a well anticipated news event, this phrase needs to be considered if markets have already priced in the bounce that we were looking for last week. 

Disclosure: Interactive Brokers

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