Stocks finished the day lower, with the S&P 500 dropping by 40 bps, as the VIX surged, rates rose, and the dollar strengthened.  A good portion of the move came today after Fed governor Chris Waller pushed back against market-based expectations on rate hikes, which added to an already strong dollar and higher rates.

The 10-year rate increased by more than 11 bps, while the 2-year rate increased by almost eight bps, which meant the 10/2 curve rose to -16 bps and is now back to its October levels. A further steepening of the yield curve is likely to happen. The next stop could see the yield curve move back into positive territory, which could come sooner, especially if the economic data continues to support an outlook with stagflation-like tilt.

Meanwhile, the S&P 500 today was supported by the 4,750 level, which contained a lot of gamma, at least for today. The index briefly dipped below the 4,750 level but found immediate support and was able to rally the rest of the day.

Tomorrow will be the VIX opex, and the hedging flows that have helped to suppress the VIX below 14 will be gone. The 14 level has been the upper bound since the beginning of the year, and that is because of the delta and gamma makeup of the options market. There is a lot of put delta at 14, likely serving as resistance.

Tomorrow, the options flow that has kept the VIX below 14 will be greatly diminished, which could allow the VIX to start drifting higher, especially if the dollar continues to show strength and the yield curve steepens further.

It is not a perfect fit, but the VIX index has been trading with a 10/2 curve.

So, in general, what this seems to suggest is that a steeper yield curve over the short term is likely to result in higher implied volatility levels, and this fits in nicely, with the S&P 500 stalling out at the 4,800 due to options positioning and potential window of weakness, that may have started. Also, there is potential for large delta positions in mega-cap names like Meta and Nvidia, which we discussed in the last few sessions and have supported the large market cap weight indexes. Additionally, this same type of positioning is present in Microsoft as well.

I know many people think the S&P 500 and the entire market should be going higher from here, and I am in the minority that thinks it doesn’t belong at current levels and should be much lower. My gut tells me that this week will play a critical role in determining who will be right and who will be wrong.

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