Treasury Settlements, OpEx, Dispersion Unwinds, and FX Risks: A Volatile Week Lies Ahead
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Key Takeaways
Treasury Settlement Dates Continue to Weigh on Equities: Since January 15, the market has averaged a 94-basis-point decline on settlement days compared to just 15 basis points on non-settlement days. With roughly $84 billion in settlements arriving on Tuesday and Thursday, liquidity headwinds for risk assets are likely to persist.
OpEx and Elevated VIX Set the Stage for a Volatile Week: The VIX closed Friday near 20.5 within a positive delta and positive gamma regime heading into Wednesday’s VIX expiration, with potential to climb toward 25 resistance, while Friday’s equity OpEx features a large negative gamma position that could amplify moves below the key 6,800 support level.
Yen and Won Strength Could Trigger Foreign Unwinds of U.S. Assets: Japanese and South Korean investment flows into U.S. equities have surged in recent months, and key currency levels — 152.50 on USD/JPY and 1,440 on USD/KRW — are being tested; a break lower could pressure foreign holders to reduce U.S. equity exposure.
Video
Fully Edited Transcript By Claude
Not a very pleasant week in the markets, with the indices all finishing lower. This week, I’m not really sure that things are going to be all that much better. Markets will be closed on Monday for Presidents’ Day, but then we’re going to get right into things on Tuesday with more treasury settlements.
We did have treasury settlements on Tuesday and Thursday of this past week. For those of you that are new, the red lines on the chart indicate settlement dates on which the market was down, and the green lines indicate settlement dates on which the market was up. We’ve been tracking this going back to October, and overwhelmingly, on days that there are settlements, we are seeing the market tend to be lower.
This week, we’re going to have more settlements — about $60 billion settling on Tuesday the 17th and another $24 billion settling on the 19th. I ran some stats going back to January 15th just to get a feel for what’s been happening.
What I found was that on settlement dates, we had three up days and seven down days. On the days the market was down, it declined by an average of 94 basis points. On settlement days when the market finished up, it only advanced by an average of 41 basis points. Then I looked at what was happening on non-settlement dates.
Again, what you see is that overwhelmingly, on the days there are no settlements, the market tends to finish higher. There were ten non-settlement days — six of them finished higher and four finished lower. On the up days, the market tended to finish about 80 basis points higher. On the down days, it only finished about 15 basis points lower.
When I look at this information, what it seems to suggest is that on days when we do finish higher with a settlement, the advances are significantly smaller than on days without settlements. And on the days when the market goes down, it goes down significantly more on settlement dates than on non-settlement dates. This analysis only goes back to January 15th — about a month and 20 trading days — so it’s not a huge sample size. But it is showing and suggesting that settlement dates are having a significant impact on markets.
I think one of the reasons this is happening is that the reverse repo facility is essentially drained. Treasury bill issuance came down, and that excess cash flooded into the reverse repo facility. Then in the summer of 2023, they ramped up Treasury bill issuance, which drained the reverse repo facility. There’s really nowhere left for Treasury bills to draw liquidity from. Initially, it looked like the hit was coming directly out of reserves. Now that the TGA is basically refilled and maybe has a little more to climb, liquidity is having to come from other sources. Based on what we’re seeing in this data, it would suggest that liquidity is coming from risk assets.
Technical Analysis
When we look at the market from a more technical standpoint, last week I pointed out in the video that these openings where we tend to gap higher after a sharp close tend to get retraced fairly quickly. This has happened on a number of occasions, and you can see again that this gap was retraced by basically midday on the 12th and the 13th. The gap at this point has been filled.
There was another big move down into the close on Friday. If we were to gap up to higher levels — let’s say we gapped up at 6,880 for some reason and rallied back — that would leave an unstable pattern and could potentially result in a gap fill by the end of the week or the beginning of next. These patterns tend to behave that way, and it’s worth keeping an eye on.
Alternatively, if we were to undercut the lows at 6,800, which has been acting as support, that would obviously change things and open the pathway to much lower levels.
Options Expiration and VIX Dynamics
This week is OpEx, and it will play a heavy hand in where the market goes from here. This week will also feature a VIX option expiration date. The VIX closed Friday up at around 20.5, which is a bit more elevated. We’ll have to keep an eye on this because we’ve had a pretty big move in implied volatility the last couple of days.
When you look at the flows for this week and the VIX for Wednesday’s OpEx, we are in a positive delta and positive gamma regime, so we don’t have those bearish forces weighing on the VIX and pushing it lower. In a positive gamma regime, if the VIX were to begin to rise, we would have market makers potentially selling into that. But at the same time, if the VIX starts dipping, market makers are probably going to be buyers of that dip. And because it’s also in positive delta territory, that could put an upward bias on the VIX. It shows that you could get all the way up to 25 on the VIX, and that’s probably where you would see some strong resistance levels.
Going into this week with equity option expiration on Friday, we’re in a big negative gamma regime. The big level right now is 6,800 as your support. If 6,800 breaks, there’s room to move down to around 6,700.
From a delta perspective, delta is getting whittled away. There’s just not a lot of positive flows right now in the marketplace. This will obviously change after next week. When we strip out this week’s options and look at what comes next, we’re at a negative $45 billion gamma level. This is going to get reduced a lot, so volatility is likely to start picking up as we move into next week.
That said, there’s likely to be a lot of pinning around that 6,800 level this week — unless we break that level, and then we could really start seeing the market move toward the 6,700 region.
Technically, we’ve just been bouncing off that 6,800 level, and a break of 6,800 opens a path to around 6,720 or so. Looking at the VIX, the upper Bollinger Band is pressing right up against current levels — not quite above it, but right in there. It’s possible the VIX continues to rise this week heading into Wednesday’s expiration, and the trend has been higher.
Implied and Realized Volatility
I think that’s more generally because implied and realized volatility levels have been creeping higher. Forgetting the 63-day kind, your 9-day and 21-day realized vol have been moving up. That points to the idea that maybe that’s why you’re starting to see volatility in the market begin to pick up on the implied front as well.
Dispersion
What’s also important to point out — we’ve talked about this before — dispersion right now in the equity market is extremely high. The dispersion index is at 36, which historically is a very high reading. As we’re going through earnings season, we’re starting to see some of those effects wear off.
The implied volatility of the VIX versus the S&P 500 constituent volatility shows a very high spread right now. Generally, as earnings season eases, this number is going to start coming back down, as it did from October into December. I would expect this number comes down into about March.
Typically, as these trades unwind, it can add bearish pressures to the marketplace. What I like to do is take the dispersion index — which measures how much stocks are trading in opposite directions from one another (for example, Walmart up 2%, Apple down 2%) — and compare it with correlations, which measure how much stocks are moving together. When dispersion is high, correlations are low.
I take the spread of the dispersion index and the three-month implied correlation index and overlay that with the S&P 500. It tracks each other fairly well. Right now, you are seeing dispersion minus three-month implied correlations coming down. I expect that to continue as we finish up earnings season, and that’s probably going to be a little bit more bearish for the markets.
Looking Forward
Going forward, I think you have two forces potentially weighing on stocks: treasury settlements and the unwinding of volatility dispersion.
The other thing we obviously need to talk about is what’s happening in Japan right now. We’ve seen volatility in Japan, especially the yen, really pick up. There’s an important level right around 152.50. If that key level of 152.50 breaks, I think that could lead to a further strengthening of the yen back towards the 150 area.
You’re also seeing the same thing with the Korean won. The Korean won is sitting on an important level of support at around 1,440. It could get down to 1,425 or maybe even 1,400.
There’s a reason why I think it’s really important to pay attention to the yuan and the yen. When we look at the flows of foreign investment — South Korean foreign investment cumulative stock holdings in the United States — there’s been a big run-up in those positions. You can see how it’s tracked very nicely with the S&P 500. The light blue line is Japanese investment funds’ total invested fund assets by country, denominated in U.S. dollars. There have been lots of flows out of Japan into U.S. dollar assets and into markets.
That’s why I think those two currencies specifically could matter a great deal. If the yen and the Korean won begin to strengthen, that could have negative impacts on people who own positions in U.S. assets. That could be another thing worth paying attention to as this week progresses.
Interest Rates
Finally, interest rates — we saw them really break down this week. It’s not really clear to me what was the driver. I know the employment number actually came in fairly strong, and I thought it was a pretty good reading.
But as I mentioned earlier in the week, and maybe a week ago too, when we were stalling out at these levels, it indicates that they’re not going up when they should be going up. Does that indicate that maybe they should be going down? Right now, they are going down, and there has been a bit of a change in trend on rates. The 30-year is clearly breaking the uptrend in a more meaningful way and starting to head lower, breaking that key area of support around 4.80 as well.
That’s all for today. Please remember to subscribe to this channel, like this video, share with your friends, and have a great weekend.
Defined Terms and Jargon
Basis Points (bps): A unit of measure equal to one-hundredth of a percentage point (0.01%), commonly used to describe changes in interest rates or index returns.
Reverse Repo Facility (RRP): A Federal Reserve program where eligible counterparties lend cash to the Fed overnight in exchange for Treasury securities; when drained, it means excess cash has been pulled from the facility back into the financial system.
Treasury General Account (TGA): The U.S. government’s operating account at the Federal Reserve; when it is being refilled through Treasury issuance, it draws liquidity out of the broader financial system.
OpEx (Options Expiration): The date on which options contracts expire and must be exercised or settled, often leading to elevated volume and volatility as positions are rolled or closed.
Gamma (Options): A measure of how much an option’s delta changes as the underlying price moves; in a negative gamma regime, market maker hedging tends to amplify price moves, while positive gamma dampens them.
Delta (Options): Represents the sensitivity of an option’s price to changes in the underlying asset’s price; a positive delta regime in the VIX suggests an upward directional bias.
Dispersion Index: A measure of how differently individual stocks in an index are moving relative to one another; high dispersion means stocks are diverging in performance, often linked to earnings season and single-stock volatility.
Implied Correlation: A metric that reflects how much the options market expects stocks within an index to move together; low implied correlation paired with high dispersion indicates stock-specific rather than broad-market risk.
Disclaimer
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