Fed Meeting Could Be the Market’s Next Big Test

Educational market commentary. Not investment advice. Not a recommendation. 

By Michael Kramer, Mott Capital Management

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The market got off to a rocky start this week but managed a pretty decent rebound after last week’s big decline. Most of the gains came on Thursday, on news that there may be a deal between the US and Iran again — something that’s been ongoing since March. Whether or not a deal actually gets signed, the market still responds every time, and I think that’s really the key. By the close, the S&P 500 was slightly above its level at the close last Friday.

The catch is that it’s still pressed up against its 10- and 20-day exponential moving averages, which are clearly acting as resistance for now, with more technical resistance stacked just overhead.

From a positioning standpoint, we’re back in positive gamma (a state where dealers’ hedging dampens moves instead of amplifying them), but only faintly. A drawdown next week could flip us back into negative gamma, where dealer hedging instead goes with the market and accelerates the move — that’s a lot of what powered Thursday’s rally. In positive gamma, you tend to get more of a pinning effect than a trend. With monthly options expiring on Thursday the 18th (the market is closed Friday the 19th for the holiday) and a lot of that gamma set to roll off, it wouldn’t surprise me if next week is fairly muted and range-bound.

 

The bigger event is the Fed on Wednesday, and I think it’s a meeting that could catch the market a little offside with a more hawkish stance. It helps to frame where we’re coming from. At the March meeting under Jay Powell, the projections had median dots (the FOMC’s rate-path forecast) at 3.4% for 2026, with the cutting cycle leveling off around 3.1% into early 2027.

Markets have repriced a lot since then. Fed funds futures are now trading around 3.80% for 2026, 3.90% for 2027, and 4.05% for 2028. That basically removes the rate-cut bias that was built into the projections and tilts the conversation toward hikes. I’d also expect a change in the statement that drops the easing bias and shifts the emphasis away from the labor market and back toward inflation.

And inflation is the part that’s gotten more interesting, because it’s stopped being only an oil story. Core CPI (prices excluding food and energy) is running around 3.1% to 3.2% on a three- and six-month basis and 2.8% over the past year — which means the one-year number probably keeps drifting higher until the monthly pace rolls over. Core PCE (the Fed’s preferred inflation gauge) tells the same story, around 3.8% on a three- and six-month basis and 3.3% year over year.

 

It shows up even in the measures that strip out the outliers. Trimmed mean PCE (an inflation measure that throws out the biggest movers each month, and one Kevin Warsh has pointed to) is running around 2.3%, and the Cleveland Fed’s trimmed mean CPI is around 2.9%. The lesson from 2021 is that the trimmed-mean measures were slow to catch up while core PCE was leading higher, and core PCE peaked first — and in 2019 and 2020, you never would have gotten rate cuts on the trimmed mean alone. If this were all oil, you wouldn’t see core running this hot on a three- and six-month basis, especially since oil didn’t really start moving until March. Goods prices have a lot to do with it: they’ve swung from negative to about 4.4% year over year, and that’s feeding the readings.

At the same time, the labor market looks like it’s turning. The ratio of job openings to unemployed workers has swung back above one and has been making higher highs and higher lows since December, and the payroll data, ADP, and Revelio Labs are all pointing the same way — a labor market that probably bottomed late last fall and is turning higher. That gives the Fed room to take its focus off employment and put it on inflation. So I wouldn’t be surprised if Wednesday’s dots show the unemployment rate ticking down and the inflation projections moving up for this year and next.

 

On the equity side, the semiconductor picture hasn’t really reset. Implied volatility on the group still sits at the high end of its one-year range, with options still leaning to the call side, and even with Broadcom and NVIDIA coming down after Broadcom’s results, names like Micron have held the volatility up. Dispersion (the gap between single-stock and index-level volatility) is still wide and implied correlations are still low — single-stock vol high, index vol low — and that hasn’t normalized even after the sharp decline of the past couple of weeks.

Video

Video Transcript

Transcript Edited by Claude (Can Make Mistakes)

The market got off to a rocky start this week but was able to put together a pretty decent rebound following last week’s big decline. Most of the gains came on Thursday, following news that there may be a deal again between the US and Iran — something that’s been ongoing since March. Regardless of whether a deal happens, the market responds, and I think that’s really the key in terms of what it all means. The main takeaway, when you look at where the S&P 500 is today versus last week, is that it’s basically sitting a little bit higher than where it closed last Friday.

The key here is that you’re still sitting at the ten-day and twenty-day moving averages, which are clearly serving as resistance for now. There are some other levels of resistance built into the market as well — both technical resistance just overhead and, from a gamma standpoint, an option structure that has a band of resistance above and support below. That option support is a good part of why the market has been able to hold up through the week.

We’re in positive gamma territory, but only faintly, meaning we could easily flip back into negative gamma next week if we were to see some sort of drawdown. That’s important, because negative gamma creates accelerant flows: in that environment, market makers tend to move with the direction of the market. The reason you saw such a big rally on Thursday is that we were in a negative gamma regime, and now we’ve moved back into positive gamma. In a positive gamma regime you typically get more of a pinning effect than a trend.

It’s also worth realizing that this week brings monthly option expiration on Thursday, June 18th, since the market is closed Friday the 19th for the holiday. There’s a lot of gamma on the board and a lot of it due to expire on the 18th, so it’s quite possible this week is much more muted. We don’t know what the headlines will be, but you could easily see more of a pinning in the market as it settles in through expiration.

The other big piece this week is the Fed meeting, and I think it’s going to be an interesting one — it could catch the market a little bit off sides with a more hawkish stance. First it’s important to frame where we’re coming from. At the March meeting under Jay Powell’s leadership, the market was looking at median dots of 3.4% for 2026 and basically thought the rate-cutting cycle would come to an end in early 2027, where the dots leveled out around 3.1% for the foreseeable future.

Since that time, markets have repriced quite a bit. For 2026, Fed funds futures are trading around 3.80. For 2027, they’re pricing around 3.90, and for 2028, around 4.05. That would remove all of the rate-cutting bias that’s been built into the SEP and potentially shift it more toward the idea of rate hikes. There should also be a change in the statement, removing the easing bias, with a shift away from the emphasis on the employment market and back toward inflation.

Although we know inflation has been driven in part by higher oil prices, it’s important to look at what’s happening with core. Core CPI has been running above 2% for quite some time now. On a three- and six-month basis it’s running around 3.1% to 3.2%, and on a one-year basis it’s at 2.8%. What that means is that core inflation on a one-year basis is likely to keep trending higher until the month-over-month rate of change begins to move lower. When we look at core PCE, we see a lot of the same: around 3.8% on a three- and six-month basis, and around 3.3% year over year.

Even when you step away from the traditional metrics, the picture holds. If you look at trimmed mean PCE — something Kevin Warsh likes to look at, and which he talked about in his Senate Banking Committee testimony — year-over-year PCE is running around 3.3%, while trimmed mean PCE on a twelve-month and six-month basis is running around 2.3%. What’s important to frame is that in 2021, when core PCE was rapidly rising, the trimmed mean measures were very slow to catch up — core PCE was leading and moving up much faster, and core PCE peaked before trimmed mean PCE peaked. It’s also worth flagging that in 2019 and 2020 you never would have gotten rate cuts under trimmed mean PCE, because it never decelerated at the same rate that core PCE did. That would have made it a lot harder for the Fed to cut 75 basis points into COVID. And when you look at trimmed mean CPI, which is the Cleveland Fed metric, that’s running around 2.9%.

So it’s really hard to sit here and say all of the inflation we have is due to oil. If it were all oil, you wouldn’t see core PCE and core CPI moving up the way they have on a three- and six-month basis. We didn’t really see oil start moving up until sometime in March. One thing I noticed going through my work: I have a chart that breaks down total PCE, core PCE, service prices, and goods prices. The goods-price line has gone from being in negative territory to suddenly positive, up to 4.4% on a year-over-year basis. So part of why you’re seeing PCE and CPI readings moving up is a reacceleration in goods prices.

When you look at the job numbers, JOLTS divided by the number of people unemployed has now swung back above one on a ratio basis. For the most part it’s been trending that way since December — a couple of months of higher lows and higher highs. And when you look at the nonfarm payroll numbers along with ADP and Revelio Labs, they’re all pointing to the same idea: the labor market appears to have bottomed sometime in the late fall and appears to be turning higher. Whether that turn persists and builds momentum, we don’t know. But it shows a clear change in trend over the last couple of months.

At this point it’s fair to say it’s time for the Fed to shift its focus from employment to inflation. So I wouldn’t be surprised that by the time we get to Wednesday and see the dot plots, you see the unemployment rate tick down for this year, next year, and 2028, and the PCE inflation rate move higher for this year and next. Maybe over the long run it gets back to 2%. I also think you’re going to see a meaningful uptick in core PCE for this year, since core PCE is already running well above 2.7% on a three- and six-month basis and looks like it’s trending higher. What this tells the market is that the Fed doesn’t really see employment as that big of a problem and sees a bigger issue right now with inflation.

Going back to the S&P 500 and how it’s positioned: as I showed last week with the top names in the SMH, implied volatility sits in a very high percentile over the past year, with the median back up near the top of its one-year range and options siding more toward the call side — meaning options are expensive. The only two names floating out at lower levels are Broadcom and NVIDIA. Broadcom had just reported the prior week and got hit pretty hard, as we expected it could, and NVIDIA has been coming down fairly hard too. For the most part, names like Micron have held up, which is part of why implied volatility levels continue to hold.

It also becomes clearer when you start looking at the top fifty or so stocks in the S&P 500. It’s still dominated by the semiconductor and hardware names on one side and a handful of software names on the other — which is, again, the bifurcation and the dispersion in the market. When you go back to the S&P itself, dispersion is still very high. That measure really hasn’t come down yet, even though we saw a pretty sharp decline in the market. Three-month implied correlations are still at very low levels — single-stock volatility is still very high while index-level volatility is comparatively low, and that’s really what’s creating the dispersion you’re seeing at this point in time.

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Glossary by Claude

• Positive / negative gamma regime: In positive gamma, dealer hedging dampens market moves and tends to pin price; in negative gamma, it amplifies them — dealers sell as the market falls and buy as it rises, accelerating the move.
• Monthly option expiration (OPEX): The third-Friday expiry where a large block of index and single-stock options roll off; the gamma tied to those strikes disappears, which can change how the market trades right afterward.
• Median dots (SEP): The midpoint of FOMC members’ interest-rate projections in the quarterly Summary of Economic Projections — a read on where policymakers themselves see rates heading.
• Fed funds futures: Exchange-traded contracts whose pricing implies the market’s expected average policy rate for a given year; comparing them to the dots shows whether the market is leaning toward cuts or hikes.
• Core CPI / Core PCE: Inflation measured excluding food and energy. Core PCE is the Fed’s preferred gauge; the three- and six-month run rates show the near-term trend better than the year-over-year number.
• Trimmed mean PCE / CPI: Inflation gauges (from the Dallas and Cleveland Feds) that discard the largest monthly price moves in either direction to show the broad, underlying trend rather than the outliers.
• Dispersion: The gap between single-stock implied volatility and index-level implied volatility. Wide dispersion means names are trading on their own stories rather than together — common in earnings season or stress.
• Implied correlation: A market-implied measure of how synchronously index constituents are expected to move. Low readings mean names are going their own way while index volatility stays subdued.

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