Setting Up for FOMC/ECB

Its amazing how you can hear a mouse squeal when the Fed is in their quiet period.  Next week, we get the one two CB combo of Fed and ECB on back to back days.  With the Fed, you have Powell who has softened his tone lately but has mostly let his lieutenants run their mouth, because well, they just want to sound like inflation fighters to boost their careers.  I can't imagine Powell doing anything to placate the bulls, but I have a consensus view, so probably close to a nothingburger at the FOMC meeting, don't expect him to go full hawk like he did at J-Hole or the Sep. and Nov. meeting, expecting more mealy mouth language that's more noncommittal, except that he'll probably say rate hikes are not done, even with the step down to 25 bps.  Remember, Powell's ego and reputation is on the line. If he wimps out here and goes dovish when stocks are in rally mode, he will lose some credibility.  That said, he can't deny that inflation is coming down more quickly than many expected, even though the labor market remains tight.  

With the ECB, you have the hawkish Lagarde who is talking smack to STIR traders in the Eurozone who are long and fading her. You had a huge bond selloff post ECB meeting in December, so that's going to be on the minds of bond investors this time around.  After a big rally at the beginning of the year, kind of neutral here on the bond market, but if I had to make a play, I would choose the long side.  Longer term, unlike stocks which look a bit rich, bonds are at decent levels and have room to go higher.  

The price action in stocks has been strong after earnings reports that have been weak.  It appears that investors are feeling more bullish these days, and you are probably getting CTAs chasing the move higher, as the SPX trades above its 200 day MA and hit a 1 month high.  The last buyers will probably be vol control funds which are just waiting for the volatility to go down a bit more before they pile in.  That could be the last push higher before this bear market rally rolls over.  A realized vol chart from @NewRiverInvest for a SPX/UST balanced portfolio.  Still elevated, but if it drops a bit more, you will see funds getting deployed in BOTH stocks and bonds. 

The resilience of this stock market despite terrible fundamentals and tight monetary  conditions is a bit surprising.  The $5+ trillion Covid helicopter money drop is the gift that keeps on giving for financial markets.  Liquidity came in like a fire hose, and the meager QT is taking it out with a paper straw.  The only plausible bull case for a long term investment in SPX at these levels is if the Fed goes right back to their 2008 playbook and cuts to zero with alacrity and goes back to unlimited QE at the first sign of deep job losses and weak economic data.  But to get to that point, ironically the stock market would have to drop a lot in a hard landing to get the Fed's attention and make them overreact to the weakness.  A soft landing isn't the best case scenario for stocks, that will only take Fed funds rate down to 2.5-3% level.  A hard landing inducing the Fed to overreact with their liquidity bazooka gun is the bull case. 

Stuck in the red on my NDX and SPX short positions.  Not willing to make Custer's last stand with these, so will hold for a couple more days and look to exit early next week before the FOMC meeting.  There is a good probability that you will have a relief rally unless Powell goes full hawk (unlikely, but not zero probability).  I will not be playing the long side even though I think we're probably going to rally late next week.  The risk/reward is just not good enough (rug pull risk is too high here).  That relief rally + the return of the corporate buyback window in February could boost this market higher for the next few weeks.  As positioning has been getting more long among asset managers in SPX and NDX, the rally will probably be small (up to SPX 4150-4200), as you've already made a big move off the December lows.