US Market Volatility Overshadows Iran Peace Talks Amid Short Squeeze

Market Rally Masks Uncertainty as Investors Seek Clarity on Iran War

A sudden surge in US stocks on Tuesday has led to speculation that investors are increasingly optimistic about a swift end to the Iran war. However, a closer examination of the market reveals that a massive short squeeze played a significant role in the rally, obscuring the true level of investor confidence.

According to data from Goldman Sachs, a basket of the 50 most-shorted stocks soared 7.1% on Tuesday, marking its second-biggest rally in almost a year and more than twice the gain of the S&P 500 Index. The S&P 500 rose 0.8% at 9:40 a.m. in New York, while Europe's main equities gauge added 2.3%. The rally was driven by a rush to dump bearish bets, as traders at Goldman Sachs and JPMorgan Chase & Co. pointed out.

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Headlines suggesting a potential end to the war triggered a massive short squeeze, with institutional funds closing out bearish bets on companies in the S&P 500. According to data compiled by Citigroup Inc., wagers against companies in the S&P 500 had stood near a three-year high among institutional funds. Meanwhile, the number of shares shorted across US-listed exchange-traded funds reached a record, according to Jefferies Financial Group Inc.

Market participants, including hedge funds and trend-following funds such as CTAs, had been aggressively shorting stocks. However, the pressure point of short gamma among options dealers rolled off with Tuesday's expiry, providing a further bullish impulse. Trading desks also projected that pension funds would direct large month-end flows toward buying equities.

The rally was further fueled by US President Donald Trump's reference to the war potentially ending within two to three weeks. However, the market's euphoria was tempered by the realization that investors have been counting on a swift off-ramp to war since its beginning. JPMorgan industrials sector specialist sales Paige Hanson noted that defining the true clearing event to revisit risk and take down recession odds is crucial.

The volume of shares traded on Tuesday failed to match the euphoria evident at the index level, with traders at Goldman describing it as only a four out of 10 in terms of overall activity. On Goldman's derivatives desk, traders observed "large hedges unwound" in the S&P 500, Nasdaq, and VIX, and ETFs.

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For the bounce to be sustained, investors may need to see more detail and clarity on the path to de-escalation. Trump's social-media post on Wednesday that he'll only consider a halt to attacks on Iran when the Strait of Hormuz is reopened has sown further confusion about how long he's prepared to continue the war.

As the earnings season approaches, the market will look for signs of how the conflict affected first-quarter results and the wider economy. Brian Heavey of JPMorgan noted that the bank's traders dealing in tech and media stocks reported quiet flows on Tuesday, with short gamma positions helping to push indexes higher. However, he cautioned that nothing in their flows suggests this is more than an oversold/tactical bounce – yet.