Fed news may already be baked in, but when it hits, markets are still going to react

By: Danny Riley

We used to have an old saying that you can always come in late the day of a Fed announcement, but that may not be the case today. As unpredictable as the stock markets are, the Fed can be even more unpredictable. The Asian markets closed mixed and Europe is trading higher after a quiet night in the global markets. This morning’s   starts with the mortgage applications, housing starts and the API.

What we know for sure is that the E-mini S&P futures (CME ticker ESZ) has been on a tear. As of yesterday’s close the S&P futures have closed higher 9 out of the first 11 trading days in September and up 7 out of the last 8. Instead of increased volatility and trade leading up to the two-day Fed meeting, we are actually seeing a lull.

Yesterday’s 1.4 million ESZs traded sounds low, but when you take out the 400,000 ESZ traded in Globex pre-open and the 550k ESU/Z spreads (S&P e-mini spread), the total day session volume drops down to an astonishingly low 450,000 contracts traded. Like I said on yesterday’s Closing Print video: “When the volumes are that low the algos can’t eat.”

The big figure

S&P 1700, Dow 16,000 and NASDAQ 3800 are all considered big figures. Currently the ESZ has rallied back to its all-time contract highs but has failed to hold above the big figure. What we do know is that all the major indices are trading at or near their respective highs.

The CBOE   (VIX) closed below 14 yesterday. The majority of the floor traders we spoke to said they felt the Fed would announce a $10bil taper and that the public has already accepted the idea.

Our view

Let’s face it, the markets are not going to like it when the headlines hit the tape and TV that the Fed is pulling back from QE3. That said, the locals are right, the public and trading community have accepted the idea of the Fed pulling back, but this leaves the question, with the S&P up so much in the last two weeks, do they sell the news anyway?

In the end, we feel confident that the indices are setting up to make new highs, but we also think today could and will be a two-way street. It is going to get really quiet after the first 45 minutes.

Then the S&P, like all the other markets around the world, will be waiting on the Fed’s next move. If the Fed decides to do nothing the S&P will rally to 1725. If the Fed announces a larger pullback from the program the bottom will fall out.

Our call is to sit on our hands. We want to see how things play out. Remember that not trading is a position. The third possibility is what we call the Fed head fake, meaning that the initial headlines tend to push the S&P initially in one direction. You’re supposed to fade the move. To do that, proper timing and a good feel for the market are essential.

As always, keep an eye on the 10-handle rule and use stops when   and options.

Ned Davis S&P Cash Study

• In Asia, 7 of 11 markets closed lower or unchanged: Shanghai Comp. +0.29%, Hang Seng -0.27%, Nikkei +1.35%.
• In Europe, 9 out of 12 markets are trading modestly higher: DAX +0.44%, FTSE +0.17%.
• Morning headline: U.S. Stock   Seen Higher Ahead of Fed News
• Total volume: 727k ESU, 1.4mil ESZ, 38.1k SPU and 34.6k SPZ traded
• Economic calendar: Mortgage applications, housing starts, oil inventories, FOMC meeting announcement, FOMC forecasts, Bernanke press conference.
• MrTopStep Closing Print Video