The U.S. stock market is experiencing a technical rebound driven by short covering rather than genuine buying based on improved fundamentals. At the same time, new Federal Reserve Chair Kevin Warsh is about to preside over his first FOMC meeting. Faced with the complex situation of conflicting inflation and employment data, the phrasing choices in the press conference could have a decisive impact on market direction.
According to a recent report from Goldman Sachs derivatives strategist Brian Garrett, hedge funds have been buying U.S. equity exposure for four consecutive weeks, but the primary driver this week has shifted from "increasing alpha exposure" to "reducing beta shorts." Goldman Sachs prime brokerage data shows the ratio of short covering to long buying is as high as 4.7 to 1, a structural characteristic that calls into question the sustainability of the current rally.
Simultaneously, the American Association of Individual Investors (AAII) bullish sentiment has fallen to a one-year low. The S&P 500 has barely moved over the past month, indicating a general lack of market direction and conviction.
S&P 500 futures are currently less than 1% from their all-time high, with some lift provided by Trump's announcement of a new deal with Iran. However, Garrett warns that Warsh will chair his first FOMC meeting against a backdrop of highly contradictory data—CPI at 4.2% year-over-year, PPI at a high 6.5% year-over-year (the highest since 2022), and non-farm payrolls adding 172,000 jobs with a three-month average of 188,000. While market consensus leans towards "keeping rates unchanged," Garrett points out that the signal selection from the press conference will determine vastly different market paths, and its potential impact should not be underestimated.
Short Covering Leads the Rally, Genuine Buying Signals Are Weak
Goldman Sachs prime brokerage data reveals the internal structure of this rebound: global prime brokerage books show an overall net buy, but the driving force comes almost entirely from short covering, not active long buying. The 4.7-to-1 ratio of short covering to long buying shows that market participants are more passively reducing risk exposure than actively betting on an upside move.
At the same time, the individual stock level actually shows a net selling posture—nine of the eleven S&P 500 sectors were net sold this week, led by Information Technology, Communication Services, Consumer Staples, and Consumer Discretionary. The Financials and Industrials sectors, which have seen net buying for three consecutive weeks, are rare exceptions.
Large-cap tech stocks are under noticeable pressure. Garrett notes that the "Mag 7" large-cap tech stocks underperformed the S&P 500 by over 400 basis points this week. Goldman Sachs' trading desk continues to observe supply pressure on the Technology, Media, and Telecom (TMT) sector from institutional investors and hedge funds, with the Mag 7 being used as a funding source for semiconductor and memory chip stocks. The software sector fell about 5% last week, dragged down by earnings reports from ADBE and ORCL.
"Dispersion Trade" Continues to Evolve, Equal-Weight Index Outperforms
Regarding market structure, the Goldman Sachs trading desk has repeatedly mentioned the "dispersion trade" theme, suggesting capital is spreading from highly concentrated large-cap tech stocks to the broader market. Garrett notes this dynamic is evident in both the "rotation of capital" and "reduction of concentration" dimensions.
Goldman Sachs had actively recommended to clients over the past two weeks options for the equal-weight S&P 500 index (RSP) to outperform the market-cap-weighted S&P 500 (SPX), when the at-the-money outperformance option cost 1.4%. Since then, RSP has actually outperformed by 2.4%, confirming this view.
The Goldman Sachs basket strategy team has further identified several "catch-up" opportunities, including: sectors where price gains lag earnings momentum; the S&P 500 excluding AI components and cyclical stocks; and shorting expensive European defensive stocks.
FOMC Press Conference: One Decision, Two Paths
Garrett characterizes the upcoming FOMC meeting as a high-stakes test for Warsh. Although the market has almost reached a consensus on the "unchanged rates" decision, Garrett emphasizes that the real variable lies in the signaling from the press conference.
He outlines two distinctly different scenarios: First, maintaining rates while signaling tightening (the market has already priced in one rate hike for January 2027) risks triggering a strong political reaction, with the 2-year SOFR potentially rising by about 15 basis points. Second, maintaining rates while emphasizing that supply-side inflation cannot be solved with demand-side tools could see the 2-year SOFR fall by about 8 basis points. Garrett concludes, "The same rate decision, different press conference, completely different outcome paths," and specifically highlights that the time value of S&P 500 zero-days-to-expiration (0DTE) options on FOMC day is worth watching.
Goldman Sachs has recently issued two important reports on the interest rate market, pointing to the judgments of "no rate cuts this year" and "a higher floor for interest rates."
Dwindling Liquidity Increases Volatility Risk, Gold Turns Structurally Bearish
In the derivatives market, Garrett points out that current market liquidity is extremely scarce—top-of-book liquidity is at very low levels. This is closely related to a market structure dominated by options trading and shrinking single-stock trading. Historically, such situations have often been accompanied by rising realized volatility.
The difference between implied and realized volatility is currently among its lowest levels in nearly two years, leading the Goldman Sachs trading desk to favor holding short-term volatility longs. One-month at-the-money volatility for the Nasdaq is currently about 1.6 times that of the S&P 500, near a 15-year high. Notably, the one-month normalized put/call skew for the S&P 500 has flattened for four consecutive days and is again approaching a one-year low, indicating clients are unwinding hedge positions, with the options market overall not yet showing panic signals.
Regarding gold, Garrett notes it has fallen about 25% from its January high, though it is still up about 25% on a 52-week basis. He believes gold experienced "meme stock-like" speculation earlier this year but has since returned to reality. Goldman Sachs futures team data shows that CTAs, ETFs, and futures markets have all turned net short on gold. The GLD call skew has fallen to a ten-year low, while the put skew has risen to a historical high. Garrett suggests that the implementation of the Iran deal could serve as a clearing event after months of gold underperformance and recommends positioning for gold upside risk through risk reversal strategies (selling puts/buying calls) or call ratio spreads.
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