Some commentators have called today the last meaningful trading day of the year. I disagree, because Friday’s Nasdaq 100 (NDX) rebalancing coinciding with a triple-witch expiration should matter, but today’s FOMC meeting is indeed the biggest of the remaining “known unknowns” for 2024. Market expectations have coalesced around a 25-basis point cut, bringing the Fed Funds target to 4.25-4.5%; the bigger questions revolve around what they might signal for future meetings.
I’ve heard the term “hawkish cut” quite a bit recently. In theory, the committee will allow the expected cut today but then signal that cuts will be slow to arrive in 2025. The signal could come through the Summary of Economic Projections (aka the “dot plot”) and/or via Chair Powell’s rhetoric during the post-decision press conference. Bear in mind that the last dot plot was offered in September, and it indicated a median projection for the end of 2025 of 3.4%, down from 4.1% in June. Fed Funds Futures for December 2025 now center around a rate of 3.75-4%. That would imply two rate cuts during 2025 (assuming one today) – fewer than the most recent SEP implied. It is somewhat unusual recently for the market to be less aggressive than the FOMC. Remember that we started the year with markets expecting 7-8 rate cuts; we’re likely to end with 4 (2x25bp in September, one in November, one expected today).
Yet the idea of today’s rhetoric being “hawkish” is hyperbolic. “Less dovish” strikes me as more appropriate. A hawkish central bank would not be willing to cut rates when:
- Core inflation running closer to 3% than the 2% target.
- Labor may be slowing, but an unemployment rate of 4.2% is not exactly worrisome – especially as monthly wages continue to rise by 0.3-0.4%
- Corporate credit spreads are near-record tight.
- Asset prices are at all-time highs.
Thus, the Fed is still biased toward accommodation. It’s only a matter of degree.
Options markets are not exactly concerned. When we look at S&P 500 (SPX) options expiring today, we see the now-customary bias to the upside, with a peak probability in the 6070-6080 level, about 8-15 points above the current index price:
IBKR Probability Lab for SPX Options Expiring December 18, 2024
Source: Interactive Brokers
That said, options expiring Friday show a generally symmetrical probability distribution centered around current levels:
IBKR Probability Lab for SPX Options Expiring December 20, 2024
Source: Interactive Brokers
Meanwhile, we see skews for near-term options showing the sort of steep skews that imply risk aversion. We have recently noted that while the implied volatilities of SPX options, both at-money and below-market, are on the low side historically, the spread between at-money options and their 10% below market counterparts are near long-term highs. This is certainly not dispelled by looking at any of the curves below. At least some traders show concern that this week’s moves could be unpleasant, while the one-month options show a very pronounced “Elvis smile”:
Skews for SPX Options Expiring December 18th, 2024 (top), December 20, 2024 (mid), January 17, 2025 (bottom)
Source: Interactive Brokers
Looking specifically at at-money options in the chart above, we see those expiring today implying a 1.55% move for the rest of today, while those that expire on Friday imply an average daily move of about 0.9%. (January options include the relatively somnolent last two weeks of December in their low volatility assumptions.) The table below, which details the 1- and 3-day moves after an FOMC meeting, starting with the December 2021 meeting. That was when the Fed signaled that the post-Covid monetary expansion would be ending in the coming months. We see that the average one-day move in absolute value terms is 1.21%, which is below the 1.55% at-money volatility for today. (Remember, volatility is agnostic about direction – it measures upward and downward moves equally). But the 0.9% implied daily volatility of options expiring Friday is well below the average 1.97% three-day directional move, and well below the average 3.58% high-low spread over that period. Interestingly when we screen for meetings that occur during quarterly expiration weeks, as the current one does, we see a similar one-day move, and a wider three-day high-low spread, but a smaller directional move.
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