Nomura Fears 'Hawkish Surprise' In Dot-Plot As 'Vol Expansion' Window Closes

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by Tyler Durden
Wednesday, Sep 22, 2021 - 09:30 AM

Is history going to repeat itself today?

The last time the US equity market 'hiccupped' was following the FOMC meeting in September 2020...

As Bloomberg notes, the environment looks similar in several ways to today’s:

  • In September 2020, the Fed noted the limits of monetary policy in dealing with the economic shock caused by the pandemic. Now, the Fed is hamstrung by high inflation and will likely have to start pulling back on accommodation.

  • Back then, House Speaker Nancy Pelosi was pushing out a stopgap funding plan without Republican support in an effort to avoid a government shutdown. Now, she is brokering a truce within her own party to push through a multi-trillion dollar spending bill while averting a government shutdown and a Treasury default.

  • Concerns over the Covid-19 virus heading into autumn were also a worry then as they are now. This headline from Sept. 18, 2020, “Wall Street’s Return-to-Office Push Finds Virus Won’t Cooperate” could easily be swapped onto stories over the past month.

And while the market is rebounding on Evergrande headlines (which, if one scratches below the surface of the headline alone, do not offer much hope for the majority of bondholders... especially dollar bondholders), and the usual pre-FOMC 'drift', Nomura's econ team is far less sanguine and sees a number of hawkish risks across the statement, updated forecasts and press conference:

  • While we do not expect a formal tapering announcement this meeting, the Committee is likely to finalize the tapering plan ahead of a November announcement. Chair Powell may provide an update on tapering parameters that have gained a consensus, potentially including the size and frequency of adjustments.

  • Data have softened and the pandemic outlook has become more uncertain but, if anything, the FOMC appears to be increasingly concerned that the primary impact of subsequent COVID disruptions will be prolonged upward pressure on inflation as opposed to depressed demand.

  • We see upside risk to the September “dot plot.” While we think the median 2022 policy rate forecast will stay at the effective lower bound (ELB), the bar for a half or full hike is low. We think 2023 will continue to show two rate hikes, while 2024 – a new addition in September – will show an additional two hikes. Concerns over inflation could result in more than four forecasted cumulative hikes by end-2024.

  • The FOMC’s updated economic projections are likely to show a flatter growth path – with downward revisions to 2021 but stronger numbers in 2022-23 – along with notably higher near-term inflation forecasts as supply chain disruptions prove more persistent than the Committee expected just a few months ago.

  • The post-meeting FOMC statement will likely include new language to signal an imminent tapering announcement, and we believe the Committee may nuance the language describing inflation as rising “largely reflecting transitory factors.”

Tying this FOMC today back into the recent US Equities spasm, Nomura's Charlie McElligott points out that it is becoming clear to me that the “window for volatility expansion” will soon be closing again thanks to “clearing” of Op-Ex- and Fed meeting- event risks, which will only further drive resumption of “reflexive vol / gamma selling” as well as hedge monetization flows that will then see spot rally (VIX ETN Net Vega has now DECREASED by 7.2mm over the past 1w into the Vol squeeze)…

UNLESS we can again realize larger daily changes (i.e. 1.5% type moves) on Index-level again in order to justify UX1 at 23 / 24 which would be prompted by a 'hawkish surprise'...

Because, have no doubt, there is still “energy” there to overshoot in either direction with some very real accelerant flows remaining on account of Dealer options positioning: currently we see SPX / SPY Dealers short ~$9.2B of $Gamma (6.6%ile, flips positive above 4411) while $Delta remains negative at -$139.1B (11.2%ile, flips positive above 4400); similar for QQQ, with REALLY negative $Gamma at -$709.6mm (1.3%ile, flips up at 375.02) and negative $Delta at -$16.5B (2.7%ile, flips positive above $373.85)

But overall, SpotGamma notes that the key to the last several days has been this: we have not see any data to suggest material put buying, despite market weakness.

If puts were bought then that would add market pressure because dealers have to short futures to hedge.  If traders come out of the FOMC needed to buy downside put hedges then that adds additional selling.

The bottom line is that we expect some large swings today, and for the market to “stage” at either 4430 or 4300 into the close today, which could set the direction for a large move into Friday.