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Potential Market Reaction After the FOMC Announcement

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PostPosted: Sun Sep 16, 2007 4:48 am    Post subject: Potential Market Reaction After the FOMC Announcement Reply with quote

The FOMC is expected to ease the money supply on Tuesday for the first time in over four years and since the tightening cycle of 2004-06, when the Fed Funds Rate was raised from 1% to 5 1/4%. Generally, over the 2000s, U.S. actual output has been below U.S. potential output, although the U.S. economy became more efficient, e.g. fewer inputs were required for a given level of output compared to the '90s. Consequently, the FOMC can ease the money supply with the implication that inflation will remain benign, while growth accelerates to close the output gap. Much of the future acceleration of growth will be in U.S. exports increasing faster than U.S. imports.

The chart below suggests at least a 25 basis points easing on Tuesday. The U.S Dollar (black line and left scale) fell to near its all-time low last week after SPX (candlesticks and right scale) rose from 1,370 in August to about 1,490 last week; the 10-year Treasury Bond Yield fell to below 4.5% (above price chart); and gold rose above $700 an ounce (below price chart). Consequently, the market has priced-in a Fed cut. Moreover, Fed Funds Rate Futures show about a 100% chance of an easing, including over a 50% chance of a 50 basis points cut.

Intermediate-term technical indicators and sentiment indicators are bullish. However, seasonality and a FOMC easing, priced-into the market, are bearish. Repositioning of short positions, which may partially explain the recent rally, is also bearish. Moreover, since the early '80s, each time SPX rose to the 50-day MA (blue line in chart) after falling over 9%, it tested the low (although, not enough observations to be statistically significant). Consequently, it seems more likely SPX will test the low, e.g. 1,370, in late-September or October before testing the high, e.g. 1,550. Of course, almost anything is possible, e.g. SPX testing the high quickly, perhaps next week, before falling sharply.

If the FOMC cuts 50 basis points, SPX may spike higher initially, e.g. to roughly 1,500, or perhaps test the high at 1,550. If the FOMC eases 25 basis points, there may be little market reaction or a pullback. Potentially, a 50 basis points cut may suggest the economy is worse than expected. However, a 25 basis points easing may indicate the FOMC will be slow to act, which will increase the odds of recession. So, either way, it may be a lose/lose situation for the stock market. Future earnings growth, particularly during earnings warning season in late September and earnings season in October, may be a more important determinant of stock market direction over the next month or two.

PeakTrader Top Buys: C KKD SIMG QLGC CTIC DNDN; Top Sells SPY (to at least partially hedge C).

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