How the US market staged its biggest one-day swing since March 2020

The volatility on Wall Street was truly unprecedented after inflation data came in much hotter than expected.

The S&P 500 nosedived as the market opened and quickly hit session lows of -2.4%. But it was all relief buying from here, closing at an unimaginable 2.6% higher.

This was the widest trading range for the S&P 500 since March 26, 2020.

S&P 500 intraday (Source: TradingView)

Inflation refuses to come down

Headline inflation inched lower to an annual rate of 8.2% in September from 8.3% in August. This reading was slightly above analyst expectations of 8.1%.

Core inflation - which excludes volatile categories such as food and energy - accelerated to 6.6% from 6.3% in August and well-above consensus expectations of 6.5%.

"Increases in the shelter, food, and medical care indexes were the largest of many contributors to the monthly seasonally adjusted all items increase," noted the US Bureau of Labour Statistics.

"These increases were partly offset by a -4.9% decline in the gasoline index."

Why the markets rallied so hard

Let's set the scene.

The S&P 500 has been on a massive downtrend with short-lived rallies for most of this year.

The most recent selloffs occurred following the hotter-than-expected inflation report on 13 September (-4.3%) and solid jobs report on 7 October (-2.8%).

The S&P 500 was already down -5.5% in the five sessions prior to the CPI print. Sentiment was already very bearish to begin with and markets were in a rather oversold position.

Data from SentimenTrader shows that retail investors and institutions have been well hedged for this year.

Small trader pul/call premium peaked in around June, matching levels seen during the pandemic selloff, the global financial crisis and the dot com bubble.

In September, institutions were at a record level of market hedges - more than three times 2008 levels - which would exacerbate a move higher when they cover.

Source: SentimenTrader

Source: SentimenTrader

As expected, the S&P 500 plummeted as the market opened. But the gap down fizzled as shorts booked gains and covered their positions, and oversold dip buyers stepped in.

The problem remains

Markets might've staged a technical rally but the CPI print is a massive disappointment for the Fed. Core inflation refuses to fall and stickier prices are more than offsetting the decline in energy and auto prices.

The Fed is widely expected to hike interest rates by 75 bps in November and another 50 bps in December.

Markets are now pricing in a peak fed funds rate of 4.85%. In the absence of any inflation relief, the fed might have to keep hiking until something breaks.