Fed’s Bowman, known for dissenting views at the Federal Reserve, has refrained from commenting on monetary policy or the economy in her recent speech. There is a possibility for insights during a question-and-answer session later.
US stock indices are showing gains ahead of the market opening, though not at peak levels. The NASDAQ index is up by 183 points, with Nvidia shares driving the increase, expecting to open at a record level due to permission to sell chips to China. The S&P index is also experiencing an uptick of 33 points.
Silence as a Signal
The silence from Bowman is, in itself, the signal. When a known dissenter goes quiet on policy, it tells us the internal debate at the Fed is likely intense and unsettled. Coupled with prior comments from Waller hinting at a summer adjustment, the picture is one of profound uncertainty at the very top. For us, this is not a time for set-and-forget trades; it’s a time to trade the volatility that this uncertainty creates.
We’re looking at the Cboe Volatility Index, the market’s “fear gauge,” which has been stubbornly hovering around 13. This is significantly below its long-term average of about 19. The divergence between this low implied volatility and the very real policy uncertainty from the Fed presents a clear opportunity. We believe buying protection or volatility itself is underpriced. Long-dated VIX calls or purchasing puts on the SPDR S&P 500 ETF (SPY) look attractive as a hedge against the market waking up to the fact that the path forward isn’t as smooth as current prices suggest.
At the same time, we cannot ignore the raw power of the tech sector. The rally is being driven by an incredibly narrow group of stocks. Recent data shows that without the top 10 largest companies, the S&P 500’s earnings growth for the first quarter would have been negative. This is not a broad-based bull market; it is a rocket ship tied to a handful of names. The news on chip sales to China only adds fuel to that specific rocket.
Dynamic for Derivatives
This creates a fascinating dynamic for derivatives. We are positioning for a rise in divergence. This means we are exploring strategies like long call options on the Invesco QQQ Trust, which tracks the Nasdaq 100, while simultaneously buying put options on an equal-weighted S&P 500 ETF like Invesco’s RSP. This play bets on the tech giants continuing their ascent while the other 490+ companies in the S&P 500 potentially struggle under the weight of a slowing economy, the very reason Waller and his colleague would be considering a rate cut.
Looking back, the period just before the first Fed rate cut in a cycle is notoriously volatile. Markets initially celebrate the “Fed pivot,” but then must grapple with the underlying economic weakness that forced the Fed’s hand. The current futures market is pricing in more than a 60% probability of a rate cut by September, according to the CME FedWatch Tool. This means the clock is ticking. We are using options to bet that the market’s honeymoon phase with the idea of rate cuts will soon be replaced by a more sober assessment of why they are needed in the first place.
