Markets Retreat Ahead of Powell's Jackson Hole Speech as Risks Rise

Markets Retreat Ahead of Powell's Jackson Hole Speech as Risks Rise 

This morning, the equity markets are pulling back after recovering to pre-dip levels, ahead of tomorrow's highly anticipated Jackson Hole speech by Fed Chair Powell, which notably will not include a Q&A session.

The VIX and VVIX are on the rise once again.

As noted by Nomura's Charlie McElligott, there has been a renewed interest in "Wingy Puts" in the US Equities Index, driven by the same factors that previously brought the market to this point. Specifically, the fluctuating options market is pricing in a potential "Hard Landing" economic scenario, with increased concerns following revisions to the BLS NFP data. This has reignited fears among those worried about a recession, particularly in a scenario where the Fed might cut rates aggressively by December (150bps or more), with SOFR options implied probabilities jumping significantly from around 12% at the start of the week to nearly 24 Delta by the end.

Beyond SOFR options, broader indicators are also fueling recession fears. Yesterday, the US Dollar hit new year-to-date lows, UST yields approached a one-year low, and crude oil neared its 2024 low, all signaling potential economic slowdown and concerns that the Fed is moving too slowly.

As a result, the "Left Tail" economic outcome has gained some momentum again, with equity index skew firming up and put skew steepening, with increased demand for downside protection in SPX, QQQ, IWM, IYR, OIH, and XLE.

Looking ahead, the potential paths for equities suggest that the "Spot Up, Vol Up" scenario I mentioned on Tuesday could continue into September's options expiration. As exposure is added back into the market, it may trigger a FOMO-driven chase, pushing markets back to or beyond all-time highs, particularly for those who have been operating under strict "De-Gross" protocols since the "Vol Shock." However, this would likely necessitate further steepening in skew as new long positions seek downside protection, with economic data continuing to drive significant market moves.

A steep skew combined with long positioning only needs a small macro data catalyst to cause a significant drop in prices, pushing the market through dealer long gamma/vega levels and triggering a potential downward acceleration. This could lead to a "convex" move lower, especially with event risks like Jackson Hole, NVDA, NFP, CPI, and the Fed meeting on the horizon, raising the possibility of another sharp market decline.