Analysis: Buckle up, say traders as Wall Street's wild ride shows no sign of end

© Reuters. People walk by a Wall Street sign close to the New York Stock Exchange (NYSE) in New York, U.S., April 2, 2018. REUTERS/Shannon Stapleton/Files

By Saqib Iqbal Ahmed

NEW YORK (Reuters) - A massive two-day swing in U.S. stocks highlights a trend that some market participants believe will be a hallmark for months to come: intense volatility.

The S&P 500 index dropped 3.6% on Thursday, a day after racing 3.0% higher on the Federal Reserve’s monetary policy statement. Over the last five sessions, the index has marked two of its biggest one-day drops since the pandemic roiled markets two years ago, leaving the benchmark index down 13% so far in 2022. The Nasdaq plummeted 5%.

By one measure - the 10-day realized volatility for the S&P 500, or how much the index has moved over a rolling 10-day period - U.S. stocks are at their choppiest since the pandemic driven selloff in the first half of 2020.

GRAPHIC: Choppy times https://graphics.reuters.com/USA-STOCKS/zgvomleazvd/chart.png

The gyrations come as investors are faced with an array of potentially combustible factors, chief among them whether the Federal Reserve will be able to tame surging inflation without driving the economy into recession.

Wednesday’s rally came after Fed Chair Jerome Powell announced a widely expected 50 basis point interest rate increase and said policymakers were not discussing larger hikes. He also expressed confidence that the central bank could steer the economy to a so-called soft landing – a view that investors seemed far more skeptical of a day later, as equities tanked.

"There is a lot of uncertainty with what is going on, with inflation, oil, global macroeconomic events," said Matthew Tym, head of equity derivatives trading at Cantor Fitzgerald. "I think we are in for some volatility going forward, probably for the whole year."

The sharp selloff sent the Cboe Volatility Index, known as Wall Street’s fear gauge, up 5.78 points to 31.20, far above its long-term median of 17.63. Tym said he believed it was unlikely the index would trade “a whole lot lower” anytime soon.

Thursday's selloff was extraordinarily broad with every S&P sector down on the day and more than 95% of the index constituents in the red.

"It's a clear 'get out now and ask questions later' kind of thing," said Chris Murphy, co-head of derivative strategy at Susquehanna International Group.

"Today's move is telling you, the Fed can't talk its way out of this, you are going to have to take some pain to fix this situation," Murphy said.

The stock selloff came as benchmark 10-year bond yields surged back above 3%. Higher yields can dull the allure of stocks, particularly those in high-growth sectors such as technology, whose companies’ cash flows are more weighted in the future and diminished when discounted at higher interest rates.

“The bond market had started to factor in inflation and central bank policy earlier and maybe more effectively than the equity market," said Brooks Ritchey, co-chief investment officer at K2 Advisors, pointing to macro hedge funds as those playing this theme. "So we may need a bit more time or even a bit more pressure for the equity market to be positioned for the new interest rate cycle."

Andrew Brenner, head of international fixed income at National Alliance Securities, viewed Thursday's sellers as funds that follow macro trends.

"It's pretty awful in the equity markets," said Brenner, saying that the selling was a response to Powell's remarks, as investors viewed him even more "behind the curve" in raising rates.

The Fed is hardly the only worry facing markets. Prices for oil and many other commodities remain sky high, partially as a result of repercussions from the war in Ukraine. Markets remain focused on inflation, with key U.S. consumer price data coming next week.

"Volatility has taken the wheel, so investors should buckle up while the market adjusts to new conditions," said Jeff Klingelhofer, co-head of investments at Thornburg Investment Management, in a note.