Market Update: 19 Mar 2022
FOMC unpacking
No immediate surprises on Wednesday with the 25bp rate hike and no shocking statements from Powell. The market reacted positively as a result.
But make no mistake, the overall message was clearly hawkish. The most aggressive we’ve seen since before the 2008 Global Financial Crisis.
1. The Fed’s forecast for hikes has moved aggressively to match the market’s expectation of 7 hikes for 2022 and 3 hikes for 2023.
2. Every FOMC meeting going forward is live with the possibility of a 50bp hike.
3. The 2024 forecast of 2.75% is actually higher than the long-run equilibrium estimate of 2.375%.
4. Balance sheet runoffs (Quantitative Tightening) to start as early as May.
A strong hawkish mandate from the Fed with the primary goal of curtailing inflation. The Fed’s ‘short call’ is firmly in place. Meaning that asset prices will probably be capped at all-time highs in the medium-term given the Fed’s clear tightening bias.
But why did markets rally when the Fed was hawkish? We were not surprised at all by the positive reaction and we are also bullish in the near-term for the following reasons:
a. China and global tech equities were oversold and the relief rally will have some momentum.
b. De-escalation and possible ceasefire in the Russo-Ukrainian conflict.
c. Further unwinding of FOMC downside hedges.
With the Fed’s cap on the topside on one hand and bullish momentum supporting the downside on the other, the obvious trade is to sell vol! The market caught on quickly with the VIX dropping sharply during the FOMC window itself.
Crypto vols
It’s been a while since we’ve seen such interesting moves and opportunities in vols.
- The market was clearly caught long gamma (short-term options). The desk saw a tremendous amount of vol selling post-FOMC. From the highs of nearly 100%, both BTC and ETH front-end vols have dropped to 60%. A truly massive move! (Chart 1)
This has caused the curve to steepen significantly as we expected from our previous update.
The overall vol collapse has been great for our core short vega (longer-term options) position. We are keeping short vega overall in anticipation of the usual quarter-end vol selling.
2. ETH front-end vols traded at a discount to BTC! (Chart 2) This rarely happens and must have been caused by larger unwinding of FOMC hedges in ETH versus BTC.
Not an opportunity we could ignore. We’ve gone long ETH gamma against short BTC gamma at a 3% discount. And short ETH vega against long BTC vega at a 12% premium.
We are now long gamma overall as these levels have to be oversold (or so we hope).
