(Bloomberg) — Stock traders reeling from the market’s worst trajectory since February are facing a number of pivotal events in the coming days, and a well-watched speech from Federal Reserve Chairman Jerome Powell may be not even the biggest test of all.
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Ahead of Powell’s speech Friday at a Fed symposium in Wyoming, traders will be looking to a crucial earnings report Wednesday from Nvidia Corp. to set the tone. A blowout forecast for rising earnings in May from the chipmaker, now the fourth-largest component of the S&P 500 index, helped spark the artificial intelligence rally that has helped the benchmark advance about 14% this year.
Powell then closes out the week. A Fed Chairman’s speech at the conference has typically boosted stocks since the turn of the millennium, with the S&P 500 gaining an average of 0.4% over the following week, data from Bloomberg Intelligence shows. But last year’s appearance is still fresh in traders’ minds: Shares fell 3.2% in the week following Powell’s comments, according to BI, after he warned to keep policies restrictive to fight inflation.
The risk this time is that he leans on the prospect of further tightening this year, which could dampen growth expectations at a time when concerns about China are mounting. It’s a scenario that would also jeopardize Wall Street’s earnings forecasts, especially for high-flying technology stocks.
“Investors are betting on a narrative that inflation is under control and that the Fed can declare victory, but it has yet to materialize — and that is the biggest risk to the stock market,” said Stephanie Lang, chief investment officer at Homrich Berg. At the same time, “unless Nvidia can translate the power of AI into earnings growth, it will be difficult to continue this rally.”
In the long run, however, the Fed’s path is paramount, with three more policy-making meetings to go in 2023. In the interest rate market, traders are trending toward a break next month and have priced in less than half of a quarter. point increase for the next decision in November.
A consumer price report this month showed inflation was subdued in July. But robust retail sales data also showed that US consumers remain resilient, which could prompt the Fed to take more aggressive policies if inflationary pressures persist.
As the sell-off in US stocks gained momentum last week, with the S&P 500 posting its first three-week decline since February, so has the hunger for option contracts that bet on more losses.
More than 25 million put options were traded on U.S. exchanges on Thursday, the highest number since the banking turmoil in March, while demand for calls remained about average, according to Bloomberg data. The measure was further increased on Friday when contracts linked to stocks and indexes expired.
“The increased put volume was a function of markets selling out to a new, lower than we’ve seen in recent times,” Rocky Fishman, founder of derivatives analysis firm Asym 500, said by email. “The closeness to the monthly due date helped push it above previous highs.”
The S&P 500 is down 4.8% in August, on the pace of its worst month this year, and the Cboe VIX index — a measure of expected swings in the benchmark — is close to its highest since May. While the stock’s weakness is hardly cause for panic, derivatives traders are certainly noticing it.
Call-buying to open a position — seen as a barometer of bullish bets — has fallen to its lowest level this year relative to puts to open a position, according to data from Options Clearing Corp., analyzed by Citi Group Inc. A similar trend can be seen in a broader measure that also includes put and call sales as a barometer for up and down bets.
The positioning puts the spotlight on the Fed symposium even more. The set-up of the meeting is “complex,” said Dennis Debusschere, president of 22V Research LLC, with rising Treasury yields weighing on long-term stocks and the battle against inflation far from over.
“Don’t expect Powell to deliver the hammer like he did in 2022,” he said in a note to customers. “We don’t think Powell will change his tune if he moves away from data dependence, which won’t be perceived as aggressive when interest rates rise and risky assets underperform.”
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