There could be more to this shutdown short squeeze

By Danny Riley
The Asian markets closed mostly higher and Europe (except for the Greek Athex) is 

 trading lower across the board. Today's economic calendar starts with the MBA purchase applications, ADP employment report, Gallup U.S. job creation index, and API. We'll have some Fed speak out of Eric Rosen, plus Federal Reserve Chairman Ben Bernanke and St. Louis Federal Reserve Bank President James Bullard's opening remarks at the St. Louis Fed's Community Banking Research Conference.

Yesterday's letdown by and shutdown of the government ended up a positive for the S&P. That is how the game is played. Everyone sells into the event and once the news is out the markets go back up. While part of yesterday's buying was new money being put to work on the first trading day of the new quarter, most of the buying was the shorts getting squeezed out again. Guess what? It's not over yet. After yesterday's early afternoon selloff and bounce back up, we just do not get the feeling that it's going to be a one-day rally.

Shutdown makes us look like global buffoons

The current government shutdown is completely unnecessary and does not help the case of the U.S. dollar around the world. There are so many things in play and we are not talking about the Army/Navy game being canceled. There are many unanswered questions:

How will the federal government shutdown affect the U.S. economy?
How long will the federal government shutdown last?
What will be the effects on business and consumers?
What about this Friday's employment number? As we pointed out, the Labor Department needs to be open in order to issue it.
What about the debt ceiling and the government running out of money on Oct. 17?
What about the Fed's taper?
As traders we are always questioning and probing. Whether it's the latest headline or a big move down in the gold we are always searching for answers. Right now traders are searching for answers from the government and not getting any.

While this is not looking like just a one-day event, we do think this will end up like all the “I can't buys” over the last few months– going higher.

Our view:

The most important thing a trader can do when looking at the government shutdown is to remember that the news is out and the short sellers have already voted. After all the huffing and puffing, the ESH (e-mini S&P) was trading 1692 in Globex at 6:00 pm Tuesday evening, only 8 handles off the “big figure” at S&P 1700, but back down hard this morning.

Sure, the S&P will be susceptible to headlines, but at the end of the day we just don't think a prolonged government shutdown serves either party's interest. Expect a two-way trade but lean to buying weakness.

Lastly, one would have to think that the current shutdown (especially if followed by a debt ceiling fight) will affect the Fed's taper plan, if you can call it a plan. If the shutdown continues, it will drag the U.S. into a downgrade and that will keep the Fed printing presses going well into next year.

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