An epic squeeze drove stocks higher this week, driven by a compilation of factors that aren’t likely to persist. As discussed previously, stocks are trading more in sync with bonds than at any time in recent memory, and this week saw a big move lower in rates, starting Wednesday morning.
The groundwork was laid out on Monday when the Treasury announced it would borrow just $776 billion from a previously estimated $852 billion in the fourth quarter. But the more significant news came Wednesday morning, before the Fed, when the Treasury boosted its quarterly refunding to $112 billion versus estimates for $114 billion. Additionally, it resulted in the Treasury announcing a 3-year auction of $48 billion, a 10-year auction of $40 billion, and a 30-year auction of $24 billion. This was less than the estimates of $48 billion, $41 billion, and $25 billion, respectively. This sent rates on the ten- and 30-year plunging on the news.
Massive Short In Treasuries
One has to remember that there is a massive short position that has been built in the 10-year and 30-year Treasuries, and even what seems like the most minute piece of news could send shockwaves through the market, especially if it doesn’t work in favor of how the market is positioned.
Rates weren’t helped by the disappointing ISM data on Wednesday or even the Jobs data on Friday, contributing to the drop in rates during the week. Additionally, it is also worth pointing out that last week saw no Treasury auction in the afternoon, which has become a great source of volatility across markets. That will change this week with a 3-year auction on November 7, a 10-year auction on November 8, and a 30-year auction on November 9.
Treasury Auctions
These auctions will be critical and could reintroduce a layer of volatility in the afternoon. The last 10-year auction did not go well, with a high yield rate of 4.61% versus a when-issued yield of 4.592%, while indirect acceptance rates plunged to 60.3% from 66.3% in September.
The last 30-year auction went even worse than the 10-year auction. The 30-year auction tailed by almost four bps, meaning it had a high yield rate of 4.837% versus a when-issued rate of 4.8%. Meanwhile, indirect acceptances came in 65.1% versus 64.5% in September. If auctions this week go as poorly as the ones of the past few months, it seems likely that bond market volatility may pick up, and it is quite possible that rates could begin to head higher again.
Buyers Missing
One of the reasons bond yields have been soaring is because the world’s largest buyers of bonds are gone, those being the central banks. The combination of the central bank unwinding balance sheet and no longer actively adding bonds to their holdings, along with a strong dollar, have decreased overall global liquidity levels, and that has had a direct impact on the price of US bonds, as noted by the decline in the US 10-Year Treasury futures. The decline in central bank balance sheets seems directly tied to the rise in interest rates and price plunge.
A Trigger For The Squeeze
Given the relationship between stock and bond prices, it is not surprising this week’s plunge in interest rates directly played the trigger in stocks ripping higher. But rates were merely the trigger in pushing the equity market higher because once rates fell, it resulted in a gamma squeeze of epic proportions from the options markets.
The S&P 500 was deeply in negative gamma territory this week. According to GammaLabs, net gamma in the S&P 500 was the lowest since the summer of 2022. Negative gamma environments produce a large amount of volatility and also tend to exacerbate moves in the market. When equity markets are in negative gamma, options dealers are buying or selling S&P 500 futures in the same direction as the market. When the market is falling in negative gamma, market makers are sellers of futures, and when the market is rising, market makers buy futures.
The combination of the decline in rates and the lack of Treasury auctions gave equity markets a clear path to rally with no interruptions throughout the trading day, and that resulted in the large amount of buying we saw all week. But the data now shows that the S&P 500 as of Friday has flipped back into positive gamma, and that means that market makers are sellers of strength and buyers of weakness. This will help to ease volatility in the market and means that the velocity of the significant gains of last week is likely behind us.
Meanwhile, the level in the S&P 500 with the most significant concentration of gamma and the level with the biggest level of call gamma is at 4,400. It will cap any further rise in the S&P 500 in the near term unless the options market moves the call wall higher by buying calls with higher strike prices. If the call wall does not roll higher, the options market will likely keep the index contained around 4,400 or lower. This is essentially why the S&P 500 ran out of energy by the end of the day on Friday.
Most of the move this week can be attributed to what happened on Wednesday morning and the positioning of the options market. It means that with the options market now back into better balance and the resumption of Treasury issuances, it seems possible that the rally we saw last week isn’t likely to advance with the same vigor.
Overall, the macro backdrop shows that the economy is slowing, unemployment is rising, and inflation is sticky. Additionally, earnings estimates for the fourth quarter and 2024 are steadily declining. The macro backdrop of stagflation will mean rates on the back of the curve staying put or moving higher as the Treasury issues more debt, and that will keep stocks contained from advancing much further, if at all.
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