The Federal Reserve's decision tomorrow morning, "bloody storm"?

The market is on high alert for the Federal Reserve's decision, with derivative trading pricing indicating that the US stock market may experience significant volatility, as bearish sentiment gathers in the bond market.

At 2:00 am Beijing time on Thursday, the Federal Reserve will announce the FOMC interest rate decision, followed by a press conference on monetary policy by Powell half an hour later.

According to Citibank, based on the pricing implied by the "parity arbitrage" trading strategy in the options market, the S&P 500 index is expected to have a 0.95% volatility on that day, making it the largest fluctuation on a Fed decision day since May 2023.

Furthermore, Citibank also pointed out that options traders have consistently underestimated the actual volatility of the S&P 500 index on Fed decision days. Since the beginning of 2022, the S&P 500 has exceeded the expected volatility of the "parity arbitrage" strategy on every Fed decision day.

In addition, bearish sentiment in the bond market has intensified.

Bearish Sentiment in the Bond Market

Futures market data as of the week ending April 23 showed that hedge funds and commodity trading advisors (CTAs) had built up significant short positions in bonds. In the words of Bank of America strategists, they are in a state of "almost maximum short positioning."

In the cash market, the latest client survey by JPMorgan also showed that bearish bets reached a three-week high. At the same time, the SOFR options market also indicated that investors increased their positions at certain strike prices, suggesting that market participants hold a significantly bearish view on the future trend of the bond market.

Due to the resilience of the US economy and persistent inflation, the market has been continuously lowering its expectations for Fed rate cuts this year. At the beginning of the year, the market expected multiple rate cuts by the Fed, but now it is anticipated that there will be only one 0.25 percentage point cut this year. Some even question whether the Fed will take any action.

Fed officials, including Powell, have stated in recent weeks that if economic data continues to show strength, they are willing to maintain higher interest rates for a longer period. Investors expect Powell to reiterate this stance after this week's FOMC meeting.

Among the continuously lowered rate cut expectations, US bonds experienced the most severe sell-off since July last year in April.

However, some analysts remain optimistic about the bond market, hoping for profit-taking by the shorts. Ian Lyngen, head of US rate strategy at BMO Capital Markets, wrote in a report this week that given the current market pessimism, US bonds could actually soar on the Fed decision day