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Volatility set to remain within the markets ahead of key data

Major US indices are at recent lows and, perhaps unsurprisingly, implied volatility is at recent highs. The S&P500 hit a psychological round number and profit-taking started to materialize. The VIX closed above 34 which is the highest volatility since 2020. We’re in for some range expansions whilst volatility is high, so a wider stop or a smaller position size is recommended.

Market Brief

This morning at the start of the London session we’re seeing some strength come back into the equity markets, but this is still a bear trend, and without a significant rise with new swing highs and higher swing lows forming, we’re still looking to sell the rips. Last Friday's low is now significant resistance, so this is where I am expecting the bears to step back in. If they don’t, for whatever reason, that signals to the bulls that a sweep above the recent FOMC high is the next logical target. The percentage of companies within the S&P500 above their 200-day moving average is around 30% and the lowest since the summer of 2020. This signals continued weakness in the benchmark index.

Somewhat interestingly though, is that implied volatility in the out-of-the-money calls rose slightly more than the puts yesterday in the Nasdaq. The Nasdaq had been leasing the large-cap stocks lower. Rising call options could signal a shift in sentiment back to the buy-side, but we would need to see them skew in favor of calls. This is going to take some time. The S&P500 Put/Call ratio is at relative highs and oftentimes, when we see stocks sell-off, we see the Puts bid relative to the Calls. When this ratio turns back lower it may then signal a bottom in this market sell-off.

The US Treasury is removing more money from the financial system than it is putting in, so the current fiscal flows show a surplus of $38,643 billion. When the US economy is running a deficit that means the non-government is receiving more money from the government than what is being taxed out. Which translates to corporate profits and personal savings. A deficit is generally what has allowed the US stock markets to keep rising.

US benchmark yields are still above 3% and inflation expectations over 10-years are somewhere between 3% and 8% depending on who you ask, or which graph you look at. The Fed is seeing 10-year inflation being priced around 3% so that is what I am using. This means the market has pushed the interest rates possibly up to the terminal point, but no one is sure. If the natural rate is higher, stocks are too expensive and this repricing we’re seeing in the markets is bringing the stocks lower because investors don’t believe the companies will be as profitable in the future.

The Eurodollar yield curve is inverted in the period 2023 to 2025 but then the markets become more optimistic, as seen in the sloping upward curve into the future. The US yield curve is flattening off, which is not an optimistic signal. These yield curves signal a couple of years of uncertainty is being priced in by the largest money markets, which commentators are saying will result in a recession induced by the removal of stimulus and hawkish rate hikes.

The US dollar is compressing under the $104.00 level and the longer this occurs, the more I am expecting a pop higher, supported by rising interest rates and yields. There are several Federal Reserve, BoE, and ECB members talking today, so I am also expecting a lot of volatility on any comment that mentions rate hikes. The US dollar could also rise on the back of a weaker euro if the ZEW sentiment reports this morning come out worse than expected.

The forex heatmap is not shedding any light on the direction of the market other than the Chinese yuan is the strongest currency which is also helping the Aussie to recover some of its losses from yesterday. Australian retail sales came in better than expected at 1.2% though the previous reading was revised down to 7.9% from 8.2%. China announced that they will be doing mass testing for COVID but that there will be additional help for small, medium, and micro-enterprises that face difficulties.

The ActivTrades sentiment indicator shows that 66% of traders are still bullish on the EURUSD as the major forex pair bounces between 1.0500 and 1.0600. This price action is within the previous week's range, which itself was within the week prior’s range. A break lower than 1.0470 will be a significant blow to the bulls.

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