European markets opened with slight changes as traders watched for news from the Middle East. The possibility of US involvement in the Iran-Israel situation kept many on edge. Still, there was a hint of optimism with S&P 500 futures rising by 0.2%. Traders are mindful of potential headlines that could impact the market.

Focus on the Federal Reserve

Next, attention will turn to the Federal Reserve’s policy decision. This decision comes right before a US holiday, adding to market concerns. European stock indices showed only small movements at the start—reflecting ongoing geopolitical tensions rather than immediate panic. The ongoing situation between Iran and Israel, with the US possibly getting involved, creates a sense of alertness without a rush to sell. Traders are not rushing towards safe-haven assets yet, but a cautious holding pattern is forming. This wait-and-see stance is evident in futures pricing and implied volatility. In the US, the slight 0.2% rise in S&P 500 futures indicates that traders believe any upcoming developments may be manageable, or at least expected to some extent. While there isn’t aggressive buying, capital is not being withdrawn either. This market behavior shows caution rather than indifference. Everyone is keeping an eye out for headlines that could significantly change market sentiment. However, any bit of calm may be challenged later by an important decision from the Federal Reserve. This comes closely before a national holiday in the US, when trading activity often drops. With fewer traders in the market, any surprising comments from the Fed could lead to sharp price changes, and we’re paying close attention to this.

Expectations from Powell

We expect Powell to keep the policy rate the same. The key question is whether the guidance will suggest patience or hint at another interest rate hike if inflation remains high. Given a minor uptick in core prices recently, any comments downplaying disinflation could unsettle what has become a confident short-vol trade. Some market players expect rate cuts as early as summer, though that seems overly optimistic in light of current data. The anticipation of rate cuts has influenced swaps and bond futures markets, leading to lower implied yields for certain time frames. If we see a change in stance on Wednesday—even just rhetorically—the yield curve may need to adjust again, which could lead to more unpredictable price movements, especially with positions still directional in rates-sensitive contracts. In the meantime, oil prices are playing a significant role in market correlations. Brent crude remains near $90 a barrel, raising inflation concerns without causing the panic seen in past conflicts. However, if a supply disruption occurs or the Strait of Hormuz is threatened, market dynamics could shift rapidly. We are closely monitoring implied volatility in energy options for any signs of changes in market sentiment. Overall, macro traders should be cautious. Current positioning in derivatives has been based on steady Fed communication and a controlled crisis in the Middle East. However, this perspective leaves room for heightened risks if either situation worsens. There’s not enough hedging activity, so surprises could lead to mispricing in the market. In the coming days, we should pay attention to calendar spreads, especially in short-term volatility, and watch for any sudden changes in market sentiment—especially in equities that reflect macro trends. While there is still demand for downside protection in index options, the increases in skew are modest. If this shifts, it could indicate that fear is escalating faster than the market can respond. With reduced trading activity expected due to the US holiday, any breaking news could lead to exaggerated price movements in either direction. This is crucial to consider, as lower liquidity can amplify reactions, especially for highly sensitive options nearing expiration. Time for repositioning may be limited if caught off guard. We plan to stay flexible in the coming days—ready to reduce exposure when signals become unclear, and willing to re-engage once the situation stabilizes. Create your live VT Markets account and start trading now.

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