Week of February 19, 2024
Dec Mullarkey, CFA , Managing Director, Investment Strategy and Asset Allocation
In the space of a few weeks, the U.S. Fed funds futures market has gone from pricing in six rate cuts this year to about three or four. The quick pullback has been the result of inflation cooling slower than expected and a still-vibrant jobs market.
Against this backdrop, Larry Summers – a prominent pundit, accomplished economist and former U.S. Treasury Secretary – is raising the odds that the U.S. Federal Reserve’s next move could be an increase. While Summers has company, his view remains in the minority.
Minutes from the Fed’s January meeting that were released this week showed none of this. Fed officials are only thinking about rate cuts. Although several did express concerns that financial conditions are less restrictive than they would like.
The Fed’s forecast is for three rate cuts this year. This is something Chairman Jerome Powell reiterated when he appeared on 60 Minutes a few weeks ago. It is rare for the Fed chairman to speak directly to the American people. But clearly, he and his team want to get their message out that measured rate cuts are in the queue, absent a major surprise or shock. And for now, the market has lined up with the Fed.
Source: Bloomberg, Financial Times, 2024.
John Bichajian III, CFA , Managing Director, Derivatives & Quantitative Strategy
With the Nasdaq 100 and S&P 500 Index approaching all-time highs this week, it is a suitable time to flag how market observers may glean insights into general investor sentiment from equity option pricing, even for those who do not trade these contracts.
We can compare changes in the implied volatility level of out-of-the-money puts relative to the implied volatility level of out-of-the-money calls (a.k.a., the skew) to assess investor sentiment toward the underlying security or index. For example, we have recently observed a decline in put skew, relative to call skew (downside protection cheapening relative to upside), which may reflect an increase in investors’ willingness to both sell downside protection and buy upside exposure.
领英推荐
The actions of market participants suggest their levels of risk tolerance. Some market participants seeking to maintain upside exposure while limiting potential equity losses may be replacing long stock exposure with call options, driving implied volatility of calls higher. Other investors able to accept downside risk should a significant selloff transpire may be increasingly selling out-of-the-money puts to collect premium, driving put skew lower. Market participants are likely concerned about missing a continuation of the rally in U.S. large cap stocks and are also willing to get long at lower levels if a sharp reversal occurs and the short puts are exercised.
Source: Bloomberg, 2024.
The information may include statements which reflect expectations or forecasts of future events. Such forward-looking statements are speculative in nature and may be subject to risks, uncertainties and assumptions and actual results which could differ significantly from the statements. All opinions and commentary are subject to change without notice. SLC Management is not affiliated with, nor endorsing, any third parties mentioned within this article.
Market insights are based on individual portfolio manager opinions and market observations. These are observations only and are not intended to provide specific financial, tax, investment, insurance, legal or accounting advice and should not be relied upon and does not?constitute a specific offer to buy and/or sell securities, insurance or investment services. Investors should consult with their professional advisors before acting upon any information posted here. It is not possible to invest directly in an index.
The use of derivatives may expose the portfolio to risks that differ, and may be possibly greater than, the risks that would be generally associated with investing in fixed income assets. These risks include, but are not limited to: i) the lack of availability of a liquid market at the time that the portfolio may want to unwind a derivative contract; ii) the possibility that the portfolio may not be able to realize value from any derivatives contract if the contract counterparty cannot fulfill its obligations under the contract; and iii) the possibility that the portfolio could experience a loss of all or part of any margin, cash or securities, on deposit with that counterparty if that counterparty goes bankrupt. There is the possibility of deterioration in the functioning or liquidity of the market for derivative instruments which may decrease the value of the derivatives instruments, thereby decreasing the value of the portfolio. Under certain circumstances, the portfolio may be unable to close out derivative contracts in a timely manner or realize values that reflect the fair market values of those investments. The posting of derivative collateral and margin could result in liquidity demands for the portfolio. The portfolio will need to hold ample eligible collateral and margin to satisfy collateral requirements. Derivative contracts may include the use of leverage. Derivative collateral may not be sufficient to close out the portfolio’s obligations under its derivative contracts.
SLC-20240223-3407503