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Index Wrap

Has the Fed turned the clock back\?

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Today marks one of the first days since January 2001, when the Fed's tone toward interest rates showed modest shift. The thought of the fed funds rate staying at 45-year lows was tweaked from fed funds staying at 1% as on December 9, 2003 the Fed said "...the Committee believes that policy accommodation can be maintained for a considerable period" to today's "...the Committee believes that it can be patient in removing its policy accommodation."

In essence, the Fed has seen something in the last month-and-a- half, which has it believing the economy may now be growing at a pace of longer-term sustainability, to begin preparing market participants for higher interest rates.

In what may be viewed as Mr. Greenspan and fellow Fed members turning back the hands of time, today might well be similar to that of May 1998. Just prior to the second leg of a powerful bull market.

Tonight I want to quickly revisit this topic, which we discussed back on August 31, 2003 in our Ask the Analyst column titled "Gold and the Fed. Too loose, too tight, or just right?"

Here's the chart of the S&P 500 Index (SPX.X) 1,128.48 -1.36% from that Ask the Analyst column. At that time (08/31/2003) the SPX was trading 1,008.01. Gold was trading at $375.70 and closed its regular session at $414.60. As I type, spot gold has just opened for tomorrow's trade at $409.40.

S&P 500 (SPX.X) - Monthly Intervals (08/31/03 Ask Analyst)

I wanted to quickly revisit the August 31, 2003 Ask the Analyst column, with special attention to the May 1998 Fed meeting, when the Fed hinted of tightening. You and I have questions about the future. What impact will today's Fed comments have on market in the future? While history is no guarantee of the future, it may help serve as a guide.

In May of 1998, the Fed hinted at tightening, but actually ended up cutting rates 1/4 point, before it started a pattern of rate hikes.

While I (Jeff Bailey) don't think the Fed will be cutting rates, anytime soon, there is still the uncertainty that the economy is currently generating job growth.

From a longer-term perspective, today's hint from the Fed that is is now leaning more toward a rate hike (probably 25-basis points at most) a trader and investor might begin thinking the SPX is at a similar level today as it was in May 1998, when the Fed began hinting of a rate hike.

Certainly times are different. There are different dynamics in play, but today's trade was all about a response to the Fed.

Let's quickly take a look at the above chart, but "cleaned up" (not all those notes) and get a clearer perspective.

S&P 500 Index (SPX.X) Chart - Monthly Intervals (01/28/04)

The above chart is to simply give us a perspective of what type of "cycle" we might expect in the coming MONTHS and allow traders and investors to begin thinking accordingly, where tests can be applied going forward.

I will say this. While there is disagreement from gold bulls that there are different dynamics in play today than there was in 1998, and that we can't use "gold $400" as a level for the Fed to be basing interest rate decisions on, I (Jeff Bailey) and perhaps you can perhaps use gold's current price level above $400 to at least make some sense of today's slight change in wording found in it brief statement.

For those interested in the FOMC archive (dating back to 1996) you can view all of the Fed's statements and minutes from these meetings at this http://www.federalreserve.gov/fomc/default.htm#2004

It is an EXCELLENT way to take a historical tour of the U.S. economy.

Let's quickly take a look at today's internals. Today's trade was rather quiet, up until 02:15 PM EST. I will explain why I think the MARKETS were SURPRISED by today's Fed statement. It's not just price action in the major indices either.

Market Snapshot / Internals - 01/28/04 Close

Maybe NASDAQ traders got an early release of today's FOMC statement before traders on the NYSE did, as the NASDAQ's A/D line turned in favor of decliners at 12:00 PM EST. Hopefully you know that I'm kidding about NASDAQ traders getting any advanced knowledge.

One sign of SURPRISE, and an unpleasant one for Treasury bulls was the jump in YIELDS just after the FOMC announcement at 02:15 PM EST. While the 10-year YIELD did edge up from its 12:10 PM EST low YIELD of 4.027% into the 02:00 hour, a sharp round of selling, as if bond bulls were SURPRISED took place.

Gold traders may also have been surprised. Fellow analyst Jonathan Levinson is constantly updating traders in the Futures Monitor as to currency and gold prices. Gold was trading a session high just prior to the FOMC announcement. At 02:20:37 PM EST, just 5-minutes after the FOMC announcement Jonathan wrote, "I can't get Globex quotes on gold or silver, but watching the tankage in the Canadian dollar futures, euros and swiss francs right now, it can't be pretty."

Currency traders in the dollar may also have been surprised. The U.S. Dollar Index (dx00y) 87.29 +1.17% jumped from 86.29 to 86.87, or +0.67% in just 5-minutes!

I made comment in the Market Monitor at 01:57:13, "Not that this will help with trader response to FOMC announcement, but if the BIX.X 356.35 +0.7% offers any clues at this point, it would be that the Fed language is going to remain "foreseeable future."

I followed that comment at 14:06:15 (8-minute before the FOMC announcement) with this intra-day chart of the S&P 100 Index (OEX.X).

S&P 100 Index (OEX.X) - 10-minute intervals (02:00 PM EST)

Banks, which tend to benefit from a low interest rate environment had broken above their MONTHLY R2 for the first time this month and were trading new 52-week highs! But the OEX wouldn't go, or follow above its WEEKLY R1.

Both the S&P Banks (BIX.X) 348.11 -1.62% and S&P 100 Index (OEX.X) 559.49 -1.35% went, as did just about everything else. South! As if SURPRISED!

OK... maybe the OEX not able to make a move above WEEKLY R1 and MONTHLY R2 was a sign that market participants weren't overly certain of what kind of phrasing the Fed was going to use, or what type of response MARKET participants were going to give, but the intra-day action of Treasuries, currencies, gold, banks and broader equities certainly had the look of an unpleasant surprise.

Pivot Analysis Matrix -

In PINK. I've highlighted today's lows in the SPX and QQQ, and also their WEEKLY S2s. Two levels stick out in my mind as it relates to notes I've made (especially in the Market Monitor) in recent weeks regarding suspicious option volume. On days with either the VIX.X 16.78 +9.3% or VXN.X +9.24% traded lower (usually associated with call buying), most active options on these days were the QQQ $37 puts (as if selling the $37 puts) and SPX 1,125 puts (as if selling the 1,125). At the time of those observations, I made the comments that the activity in those options, in relation to a lower trade found in the VIX.X and VXN.X suggested there might be a near-term "floor" of support where institutions were selling those puts, with intention to buy these levels.

I should add. When making the QQQ $37 put observation, there was also high volume levels found in the QQQ $38 puts. At these times, different month expiration trade was found, but the cost of buying the $38 puts was equal to that of selling the near- month $37 put.

If a trader were to trade off of this relationship, then a current range from $37-$38 would be suggested for the QQQ.

I thought Jim Brown made a good comment late this afternoon (Jim always makes good comments) when warning bears to not be overly aggressive with shorting, and to well expect volatility. Look at tomorrow's DAILY S2-R2 range, which certainly suggests the potential for volatility.

I've "X-d out" the WEEKLY Pivots in the INDU, SPX and OEX. Intra-day trade showed these major indices cutting down through these levels like a hot knife through butter. I would currently look for the WEEKLY Pivots to be a near-term level of resistance.

I did see some intra-day stability at the NDX/QQQ WEEKLY S1 and MONTHLY R1 for about 20-minutes. I profiled a QQQ bullish trade in the market monitor at $37.40, and while the QQQ struggled to $35.58, sellers overcame buyers, I was stopped out at $37.25 and the QQQ fell directly to its WEEKLY S2.

The slicing through of the WEEKLY Pivots in the INDU/SPX/OEX is not to say there wasn't buying taking place, but after the FOMC announcement, I could not reset my buy and sell program premium alert levels fast enough. You can probably see from the intra- day internals the BIG increase in volume from 02:00 PM EST to the close, and institutions were active.

My main points here are for new entries, (long or short) keep your position size small. If you want to trade larger sized positions, then follow with tighter stops.

S&P 100 Index (OEX.X) Chart - Daily Intervals

The MONTHLY interval chart of the SPX shown earlier doesn't look like as much selling took place as a daily interval bar chart of the OEX does. Intra-day trade had the appearance of a "garage sale" where everything was sold, and it didn't matter at what price. I would have to view the WEEKLY Pivot as resistance as stock bought at 561 by computers will most likely find some of it being sold back at the WEEKLY Pivot. Should the OEX fall much below the WEEKLY S2 and rising 21-day SMA, then a trade lower to 553 is not out of the question.

Dow Industrials (INDU) Chart - Daily Intervals

I did not want to scare investors or traders into thinking that the major indices will fall 22.4%, like that period noted in the second chart of tonight's wrap. However, a 7% to 15% decline would be considered a "normal" correction for a major index after a big bull run.

I personally, believe that while a 10% correction at some point is in order, the amount of bullishness these markets have shown in the past couple of months, where the bullish % charts have remained so overbought, yet bullish, will have the major indices higher by year's end than witnessed earlier this week. Still, I would not want to be "too wrong" and show bullish complacency.

NASDAQ-100 Tracking Stock (QQQ) - Daily Intervals

The Q's saw heavy volume today, nearly equaling the 112.3 million shares found on January 21, the day after the QQQ traded its recent 52-week high of $39.00. I make note that the Q's have fallen 5.1% from that peak high. While the QQQ looks near-term "oversold" it is an index of momentum. Bulls can pick away, but I'd use a tight stop. In recent months, the Q's have tended to move in equal $1 increments, and I would suggest $0.25 stops from an entry point if at all possible. With the Q's once again piercing below the upward trend from the March lows, I've placed a conventional downward trend from the recent high, where I would begin to deem $37.97 as a more formidable level of resistance.

Jeff Bailey

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