Daily Wrap: Knee Jerk Edition

There's a reason I warn of the knee jerk reaction, and how it is almost always wrong, before every F_O_M_C event and I have been for 7+ years, as said earlier today and yesterday, the knee jerk reaction typically lasts from 2 hours to 2-days (I gave an earlier example of the Sept 13th 2012 announcement of QE3 and it's initial knee jerk up which reversed the next day and didn't see those levels again (after losing 8% on the announcement of what the market was looking for, more QE) for another 4 months.

While the F_E_D's policy statement seemed benign and not much changed, smart money didn't seem to take it the same way as evidenced by the CONTEXT Model (see the bottom of the post for an explanation of CONTEXT).

ES/SPX futures are in red, the CONTEXT model based on what other risk assets are doing is in green. At 2 p.m. you can see a huge divergence between CONTEXT and ES, it currently sits at a -32+ ES (S&P futures) point negative differential, risk assets trading together would ideally have a differential of zero.

One of the most obvious signs of a "Risk Off" move among smart money would be found in the carry trade which is bought to leverage positions when going long or leverage AUM-Assets Under Management, rather the carry trade was sold off, one of the reasons CONTEXT looks as it does.

USD/JPy  looked like this...

Sold off, even pierced the $102 level which the Bank of Japan has been defending. When the carry trade fades, managers are moving away from leverage/risk. The EUR/JPY Carry trade was also sold.

This weekly chart of USD/JPY goes back to 2011 and shows how institutional managers leverage up when in a risk on mode...

The carry trade is opened and moves higher as the USD/JPY does here vs ES (purple), a far cry from this afternoon's selling of the carry pair.

Another institutional risk asset that would "normally" move up in a true risk on move would be High Yield Credit, here it is today vs the SPX...

HY Credit didn't budge with the SPX, lending further credibility to the "Knee Jerk" reaction.


It's interesting that the short term market manipulating SPY Arbitrage would have to be used, but it was.

 Just after the 2 p.m. announcement the environment for SPY went slightly negative and then the SPY arbitrage consisting of 3 assets (to move the SPY up, HYG must move up, TLT and VXX down).

HYG moved nearly perfectly tick for tick with the SPX as the SPY Arbitrage lever was activated, but it seemed to have some trouble at first as TLT (20 + year treasuries ) were up.

TLT in blue vs SPX (green), for SPY arbitrage to work, TLT must have relative weakness along with VXX vs. HYG's relative strength. If you look carefully at SPX price you can see the initial move was not as sharp as it was when TLT showed weaker relative strength, boosting the SPY Arbitrage.

 The 3rd asset in the SPY Arbitrage model is VXX, this has to be monkey hammered down and boy did they, in fact...

VIX closed at lows not see since February of 2007!

This gave momentum to the Most Shorted Index as it squeezed...

Russell 3000 Most Shorted Index (red) vs the SPX (green), this is likely another reason there was no confirmation of the move wither pre or post Yellen as short covering is not accumulation and certainly not by strong institutional hands.

However, interestingly, among the SPX Industry groups, the one to finish with the greatest gains today, twice that of any other sector, was the defensive Utilities, up 2.27%.

As shown twice after the F_O_M_C, we had no confirmation among even the shortest term charts, with VIX not trading overnight, it will be interesting to see how Index futures fare as they have stalled out as of now...

Russell 2000 futures along with NASDAQ and SPX stalled out totally flat just after the close (red vertical line).

And as we saw in to the close, especially in SPY, there appears to have been a quite strong churning event.

Churning on 5 min SPY chart, there was zero % gain during the largest volume of the day at least the last 7 days (5 min bar) (as far back as I can go on a 5 min intraday chart)

The last 3 mins when this volume occurred didn't see any gain, in fact a slight loss of $.04, in fact the last 15 minutes of SPY trade saw no gain, actually a small loss as it flat-lined.

We know to expect the knee jerk reaction after an F_O_M_C event, that they tend to be very transient, that they tend to be wrong as price reverses, but why would smart money be running in the other direction (not only no 3C confirmation, but a 30+ Es point differential in CONTEXT?

While on the surface the F_O_M_C policy announcement seemed quite benign, if not contradictory, especially as it relates to an 8 month trend that has seen inflation double which Yellen called "Noise" in her press conference, if you looked closer...

The GDP forecast for 2014 was cut from 3% in March to 2.2% currently. In addition the Fed Funds Rate Forecast that the market is concerned about crept up, even though there's 3 new voting doves on the F_O_M_C this meeting. The former 2015 end of year FED Funds rate was 1.1% in April, it climbed to 1.2%, the 2016 forecast was 2.4% and climbed to 2.5%.

As the WSJ's Jon Hilsenrath said in his article 9 minutes after the release of the minutes, ")The) F_E_D's new interest rate forecast imply slightly more aggressive credit tightening plans taking shape, more than previously thought", and that seems to be the data that was pulled out of an otherwise "boiler plate" (as it is being called)  policy statement.

As previously mentioned, with such a SPY Arbitrage dependent move (evidenced by the flat futures right as the market closed as VIX doesn't trade overnight), it will be interesting to see how Index futures trade through the overnight session and in to the next day or so as Quad Witching sneaks up this Friday.















*Context model:The world has become an increasingly inter-connected place to trade. Whether due to central bank liquidity or the shortening of business cycles, asset-classes tend to behave in highly correlated ways most of the time. The CONTEXT framework attempts to distill the world’s ‘risk’ asset-classes (interest-rates and curves, credit risk, FX carry, commodities, and precious metals) into a single-measure that can be judged against the US equity market in order to comprehend potential mis-pricings (or technical flows and liquidity impacts). Institutional and algorithmic clients tend to use CONTEXT as a confirmation tool for positioning against (or with) a trend. CONTEXT provides a 24-hour-a-day real-time indicator of the world’s risk appetite and whether US equities are over- or under-pricing that risk.