The week ahead- February 24, 2025

Friday’s market action was driven by a combination of key technical and fundamental factors. Options expiration (OPEX) and negative gamma dynamics played a significant role in amplifying volatility. With VIX options expiring on Tuesday and Friday marking a major OPEX day (around $2.6 TR of notional open interest across equities indices, stocks and ETFs), the market was positioned in a negative gamma environment along with volatility traders positioning in the ~5590 to ~6100 territory. This setup exacerbated volatility, increasing downward pressure on equities and making indices more susceptible to trend lower during this period.

Beyond technical factors, weaker-than-expected economic data and fiscal uncertainty further weighed on sentiment. The S&P 500 fell sharply, closing down ~2% from its all-time high, largely due to disappointing PMI Services data, which dropped below the critical 50 threshold—signaling contraction. This marked a significant shift, as services had been the primary driver of economic resilience while manufacturing struggled.

Consumer sentiment also deteriorated, adding to the market’s concerns. The University of Michigan’s survey revealed a sharp increase in long-term inflation expectations, rising to 3.5% versus the expected 3.3%, and up from the prior reading of 3.2%. This unexpected jump heightened fears that inflation expectations could become entrenched, pressuring the Federal Reserve to maintain a restrictive policy stance for longer.

In response, equity markets broadly declined, with small-cap stocks suffering the most. The Russell 2000 fell deeper into correction territory, down 10% from its recent high. Meanwhile, bonds rallied, with TLT posting strong gainsas investors sought safety in duration. Volatility surged, with SPX implied volatility rising above TLT’s for the first time in weeks, reflecting increased market stress.

Balance sheet runoff at slower pace

FOMC meeting minutes discussed Slowing down the Federal Reserve's balance sheet runoff. A slower QT pace means the Fed is reducing reserves in the banking system more gradually, preventing liquidity stress and keeping short-term funding rates lower. This results in looser financial conditions, which can support borrowing and lending activity. Also, A slower runoff puts less upward pressure on long-term Treasury yields, helping to support bond prices and flattening the yield curve. This can benefit rate-sensitive sectors like housing and corporate debt markets.

This week, market participants should brace for heightened volatility as tariff discussions dominate the landscape. While the likelihood of full implementation remains low, the rhetoric from President Trump is expected to escalate throughout the week, keeping traders on edge.

Upcoming Data Releases and Market Impact

Key economic releases this week include durable goods orders and the second estimate of Q4 U.S. GDP. Friday’s PCE inflation report will be the primary monetary policy event of the week, setting expectations for future rate cuts. While current Fed projections still indicate two rate cuts for the year, any surprises in PCE could shift those expectations.

Housing market data remains a concern, with mortgage applications declining and sentiment indicators dropping. Rising mortgage rates, coupled with unaffordable home insurance in some regions, are weighing heavily on homebuyer demand. Existing home sales and housing starts also posted weak numbers, reinforcing concerns about the sector’s health.

Yield Curve

The yield curve remains in focus, with the 3-month to 10-year spread continuing to flatten. The bond market showed strength last week, with TLT outperforming SPX by over 2%, reflecting investors' cautious stance. The FOMC’s latest minutes hinted at concerns over fiscal policy uncertainty, with a potential slowdown in the balance sheet runoff. On the employment front, initial jobless claims remain stable, but severance-related delays could mean the real impact of recent layoffs won’t be visible for several weeks.

Signs of inflation

Inflation data from multiple countries came in hotter than expected. This suggests that while disinflation trends exist, central banks may need to remain cautious before committing to aggressive rate cuts. Japan’s inflation trends also continue to climb, adding pressure on the yen, though much of its movement is influenced by the weakening U.S. dollar rather than domestic strength.

Earning to watch

Nvidia’s earnings on Wednesday will be the most significant corporate event of the week. With AI and semiconductor stocks being a key driver of market returns, any deviation from expectations could trigger substantial price swings. Focus on forward guidance and data center growth metrics. Other notable earnings include Home Depot, Best Buy, and Salesforce.