‘Sell Your Hedge and Move On’: Anxious Stocks Surge After Powell
(Bloomberg) -- Stock traders prepared for the worst -- and didn’t get it.
That may be the best explanation for how a seemingly hawkish turn by Jerome Powell translated into the biggest rally since 2020 on the day of a Federal Reserve decision. Traders laid in hedges, braced for Armageddon, and then turned tail when Powell balanced his rates outlook with a strong dose of economic optimism.
Once it became clear that stocks had found a floor, investors who bought bearish options started to unwind them, contributing to the late-day rally.
The S&P 500 climbed 1.6%, almost erasing the loss in the previous two sessions and marking the best Fed day in 13 months. It ended two points from an all-time high. The Cboe Volatility Index dropped 2.60 points to 19.29, halting a two-day advance.
“It seemed like there was some hedging demand into the event, perhaps relief that the event has happened, regardless of outcome,” said Danny Kirsch, head of options at Cornerstone Macro LLC. “The event is gone, sell your hedge and move on.”
Yes, Powell announced plans to end the central bank’s asset-buying program earlier and policy makers individually signaled that they favor raising interest rates in 2022 at a faster pace than previously expected. But bulls took solace in Powell’s robust endorsement of the economy, characterizing demand and income as strong. They also were emboldened by prospects in the central-bank dot plot for fewer rate hikes in 2024.
“What I took away from the press conference was Powell is pretty upbeat about the economy,” Bill Dudley, former Federal Reserve Bank of New York President and Bloomberg Opinion contributor, said on Bloomberg TV.
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The pre-decision defensiveness among traders was obvious in the options market. Heading into Wednesday, the 10-day average of the Cboe put-call ratio hovered near the highest level in 13 months. Total equities put volume over the past 50 days climbed to an all-time high, according to Nomura strategist Charlie McElligott who said before the Fed that the market was ripe for a bounce should a “hawkish surprise” scenario be avoided.
Of course, if it was only positioning that led to the surge, then Thursday could be eventful -- just as the past two post-decision sessions have been. After all, the market is now staring at the potential for three hikes next year after three years of not having to worry about even one. Though some investors praised the Fed’s recognition that inflation needed to be addressed with some urgency.
“We believe the initial positive equity market reaction is due to investors gaining confidence in the Fed’s willingness and ability to fight inflation,” Chris Harvey, head of equity strategy at Wells Fargo & Co., wrote in a note to clients. “As a result, they are decreasing the odds of stagflation and policy error.”
What started as a rally driven by positioning likely drew other buyers, many of whom had been dialing down their risk appetite in the past month as the omicron variant emerged and Powell signaled a change in heart on price gains. Take hedge funds. They slashed equity exposure at the fastest pace since April 2020 as their concentrated bets in speculative software firms came under fire with the specter of higher rates putting pressure on richly valued stocks.
Now there are signs that such skepticism has been walked back. A basket of expensive software shares jumped 2.8% Wednesday while an exchange-traded fund tracking hedge-fund favorites added 1.5%.
“The markets were sufficiently de-risked and positioned for a hawkish statement,” said Chris Murphy, co-head of derivatives strategy at Susquehanna International Group. “The markets have rallied a bit here because we saw investors gross down into the event, and now that the event/overhang is over we are beginning to see a little bit of market strength after the event.”
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