Oversold Signals Clash With a Rapid Shift in Rate Expectations
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The S&P 500 dropped sharply on Friday, falling more than 1.5% to finish at its lowest level since September. The index is technically oversold — trading below its lower Bollinger Band and with the RSI below 30 — setting up a potential bounce. But if the market fails to hold here, there isn’t much support below, and a deeper pullback could come quickly.
The VIX 1-day spiked on Friday and should fall once the market opens Monday, which could offer some short-term support. But even my Vanna model — a new tool I’ve been building over the past week — suggests the buying power from a vol crush has been largely exhausted. It helped flag the weak rally earlier last week, and while it’s still being refined, it’s signaling that any bounce from here may be short-lived.
What makes this more than a simple technical story is the rate picture. Fed funds futures are now pricing in rates near the current upper bound through year-end. The market has gone from expecting cuts to pricing in the possibility of a hike in a matter of weeks. And it’s not just the U.S. — the euro area is pricing in multiple ECB hikes before year-end, and the UK is even further ahead, with SONIA futures implying more than three rate hikes. The repricing in rates has been violent, and the most severe moves have been in the UK.
It’s not just the U.S. — the euro area is pricing in multiple ECB hikes before year-end.
The UK is even further ahead, with SONIA futures implying more than three rate hikes.
The repricing in rates has been violent, and the most severe moves have been in the UK.
So while the S&P 500 looks oversold on a technical basis, the fundamental backdrop may not support a sustainable rally. Shifting from an easing cycle to a tightening cycle in just two weeks is a rapid and significant regime change. Bond market volatility has soared, which is not supportive of equities. And if the rate outlook is correct, the index likely hasn’t fallen enough — a reversion to historical median valuations would imply significant further downside from current levels.
Of course, if oil prices fall, all of this could reverse quickly. But the longer oil stays elevated, the more entrenched these views become — similar to what we saw in 2022.
-Mike
Defined Terms and Jargon by Claude
Bollinger Band: A technical analysis tool that plots bands two standard deviations above and below a moving average; trading below the lower band suggests a security may be oversold.
RSI (Relative Strength Index): A momentum oscillator ranging from 0 to 100 that measures the speed and magnitude of recent price changes; readings below 30 are considered oversold.
VIX: The CBOE Volatility Index, often called the “fear gauge,” which measures expected 30-day volatility of the S&P 500 based on options prices.
Vanna: A second-order option Greek that measures the sensitivity of an option’s delta to changes in implied volatility; a “vanna model” estimates the mechanical buying or selling pressure from dealers as volatility shifts.
Vol Crush: A sharp decline in implied volatility, often after a catalyst passes, which can trigger dealer hedging flows that support the underlying market.
Fed Funds Futures: Exchange-traded contracts that reflect market expectations for the future level of the federal funds rate, used to gauge the probability of rate hikes or cuts.
SONIA (Sterling Overnight Index Average): The benchmark interest rate for overnight unsecured lending in the UK sterling market, analogous to the US federal funds rate.
Multiple Contraction: A decline in a stock or index’s price-to-earnings ratio, meaning investors are willing to pay less per dollar of earnings, typically driven by rising interest rates or deteriorating sentiment.
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Spot on re: regime change. Bond vol is not good. Should force some pod shops to degross. Either way, higher bond yields will dampen equity returns. Also with Hormuz closed still, GCC funds might very well be forced to scale down.