(Bloomberg) -- With the biggest US stock drop since March, two forces behind this year’s market resilience are on the cusp of unraveling. 

Morgan Stanley’s sales and trading desk warns trend-following traders are closer to unwinding their outsize market positions, while options dealers look poised to divest in a bid to hedge their equity exposures. 

The bank’s analysis sheds light on the deteriorating technical backdrop after Thursday’s selloff that’s largely been blamed on the Federal Reserve’s hawkishness. Jerome Powell and Co. this week touted their resolve to keep interest rates higher for longer — spurring a broad retreat in risk appetite with equity indexes breaching key thresholds. Morgan Stanley’s data suggests the selloff could intensify.

“A hawkish Fed has shaken the market, and while not yet at the point of activating significant forced selling, that point is getting much closer,” the team led by Christopher Metli wrote in a note titled Fragility Rising around the market’s open on Thursday. “Even at flat prices, trend signals in the market will start to turn negative.”

Stocks fell for a third session Thursday, with the S&P 500 falling 1.6% to the lowest level since June. Along the way, the index undercut its 100-day moving average for the first time since March. The benchmark also dipped back below its 10-day and 50-day averages after flirting with them since August. These trend lines are widely watched by traders to gauge the market momentum. 

The breach is an ominous signal for a slew of rules-based funds like commodity trading advisers, or CTAs, that surf the momentum of asset prices through long and short bets in the futures market. Up until August, this cohort of quants had been flocking to stocks, driven by a 10-month, 25% rally that defied doomsayers. 

“Absent a rebound in spot, trend following CTAs will likely start to be sellers over the next few days,” Metli said. 

Another player whose positioning is shifting: Dealers on the other side of options transactions who are obliged to buy and sell stocks to maintain a market-neutral stance. Their exposure, known by esoteric concepts like gamma, was citing for contributing to this month’s market calm. 

Now these market makers are becoming a potential source of volatility. The team estimates they would need to dump roughly $7 billion of stocks should the market drop 1% while a 2% down day would spur about $18 billion of share disposals.

To be sure, positioning among options dealers was similarly negative in August and no material damage was done. This time, it remains to be seen whether the Fed’s hawkish message is enough to drive bigger losses, Metli and his colleagues said. 

While stocks suffered one of the year’s worst sessions Thursday, trading volume stayed in line with the three-month average. The Cboe Volatility Index, Wall Street’s fear gauge known as VIX, climbed for the fifth straight day. Though at 17.5, it still sat below its longer-term mean. 

“It is not a done deal that an incrementally hawkish Fed has the ability to be that negative catalyst this time around,” Metli wrote. “But further pricing out of cuts – to maybe shifting to actual hikes – could be a problem, particularly as policy will naturally tighten (real rates rising) at the current pace of CPI declines.”

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