Megaphone In The S&P, Vol Compression In Bonds

Stock market chart

Stocks finished higher on Friday, rising another 1.2%, as optimism surrounding the war in the Middle East helped drive trading, alongside options expiration flows. However, weekend headlines suggest that some of that optimism may be based more on hope than on reality, as Iran pushed back against President Trump’s claims about reopening the Strait of Hormuz. From where I sit, it remains unclear what is actually happening.

IG weekend oil prices are trading higher by around 4%, suggesting oil could open higher by a similar amount if those gains hold. The same is true for the US Tech 100 (a proxy for the Nasdaq 100), which is trading lower by roughly 70 basis points, implying futures may open lower by a similar margin. Beyond the expected opening levels, there is little additional signal to extract from this information.

The S&P 500 is now technically overbought, with price trading above the upper Bollinger Band and the RSI above 70. Of course, the rally could extend further, but the odds at this point would favor either a pullback or a period of sideways consolidation.

Additionally, following its sharp move higher, the index has formed a broadening wedge pattern. These are not easy patterns to interpret. A breakout to the upside is certainly possible—and may even be favored given the prevailing bullish trend—but more than anything, it reflects a growing sense of indecision in the market.

I have always struggled with these types of patterns. So at this point, I think it is worth watching these for a failed breakout attempt or throw over. If you can consolidate for a few days above the upper trend line, or if that trend line becomes support, it strengthens the case for a breakout to the upside targeting around the 8,000 level on the SPX. While breaking down, it would push us to fresh lows.

Meanwhile, implied volatility in the TLT ETF once again moved back to its lowest levels since the pandemic—somewhat surprising given what is taking place globally. Additionally, realized volatility has been steadily trending higher, so while the market has been pricing lower implied volatility going forward, realized volatility has yet to show signs of rolling over.

Realized volatility at 11.5% implies roughly a 72-basis-point daily move in TLT, but with nine-day realized volatility at just 7.5%, it is possible that one-month realized volatility may begin to decline, which would validate the move lower in VXTLT. However, it would only take around a 50-basis-point daily move in TLT for volatility to shift back to a rising trend.

The sharp decline in bond market volatility certainly helps explain part of the explosive move in equities. However, with bond market volatility already near its lows, it is fair to ask how much further it can fall—and what the odds are that it begins to rise from here. At this point, the probability of higher bond market implied volatility appears elevated.