As September’s quadruple witchcraft comes to an end, markets remain cautious about the next FOMC meeting on September 22. Most seem to underestimate the true power of the derivatives expiration as it dictates the price action of the first month’s futures, which then affects large cap stocks, especially technology as they constitute more. 20% of the market index. Prior to this expiration event, there was significant open interest around 4450 and 4500. This meant that the market was “stuck” between these levels as market makers were forced to buy and sell futures contracts for. make sure they remained stable after expiration. This tends to keep the market fixed and unable to move freely.
With that over, and now?
There have been many worrying warnings about September’s seasonality and the “correction” in October, especially given the high valuations and the growth of the US economy currently leveling off. But since when does it really matter? One of the main drivers of this market has been and will remain liquidity. Since last week, the Fed’s balance sheet has hit a new record high of $ 8.45 trillion. Much has been said about the Fed’s phasing out, with the market expecting a $ 5 billion to $ 10 billion reduction in MBS and Treasury assets in November, which is expected to happen by mid-2022.
This rate of change in sentiment is what drives low sentiment right now because no one wants to touch anything cyclical or QE. We can see how badly raw materials like copper, gold, silver and iron ore have been battered. Do not paint them all with the same brushstroke because each one has its own pilots which it is important to distinguish.
The Fed has said time and again that it will provide monetary accommodation until the economy and jobs hit their targets. By that, they mean full employment at pre-COVID levels. So far, we’ve still seen about 12 million Americans out of work since the last monthly draw, but now that they’re expired, we should hopefully start to see more returning to work. Inflation can cause these plans to roll back.
The Fed’s preferred gauge of CPI, which really doesn’t show the whole picture, is still within the Fed’s tolerance level. The latest print showed a slight dip from July highs with a monthly rise of just 0.3% vs. 0.4% expected. They are still quite high year over year around 5.1%, but at least management is showing signs of easing. We all know the real inflation figure is much higher. Just look at the prices of food, energy and gas across the board. Inflation is much stickier than central banks imagined, but inflation isn’t necessarily a bad thing. Deflation is worse. As long as inflation is contained, stocks and bonds can participate in a healthy way. This is when growth begins to slow down and inflation rises – this is the most adverse set of conditions. And that’s exactly the nervousness of the market right now.
Yields on 10-year US bonds are in a narrow range between 1.2% and 1.35%. If that were to tip up, we all know that rising yields will kill all asset classes. It remains to be seen, but the Fed will cap gross bond yields because it can’t let it get away from them. For now, the context of weakening inflation has saved them time. But sooner or later, they will have to wean the economy off free juice.
The big question is: can the market survive without it?
All eyes are on the Fed’s Powell and the September 22 FOMC meeting. The market will be looking for clues to the anticipated reduction as this is the key to all asset classes and the dollar right now. At the end of the day, this is just a big macro trade.
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