How To Play The Fed

July 27, 2001
Marc Dupee

The weakest gross domestic product figure (GDP) since 1993 and falling
inflation, boosted the odds of further Fed easing. Today’s anticipated
headline GDP number came in at +0.8%, its lowest level since 1993 and the
GDP price deflator fell on an annualized basis to 2.3% from
3.3%.

The GDP report could give the Fed more leeway in lowering interest rates
and ups the ante that the Fed will lower interest rates in coming FOMC
meetings. Today’s economic development sets up a potential play in Federal
Funds futures, but first, an overview of the bigger debt contracts.

T-bonds
(
USU1 |
Quote |
Chart |
News |
PowerRating) exploded on the GDP news, rallying more than 1 point
in the first 90 minutes of trading. T-bonds were contained by the 103 29/32
first-resistance area from the Levels
From The Bond Pit, where they formed intraday (five-minute bars) double
tops. From there, bonds traded lower and found initial support just below
the measured-move objective of their intraday double-top formation. (The
measured-move objective was twice the distance of the peaks to the valleys
with the peaks at 103 30/32, the valley at 103 23/32, and therefore, the
first objective at 103 16/32. To learn how to calculate measured moves, see
Marc Dupee’s article in the Futures
Education section).

The measured-move objective down coincided with the 38.2% retracement
(again on the five-minute chart) of the morning burst. But since the contract
has traded below this confluence in its most recent swing down to 103
14/32, T-bonds were more likely to test to the 50% retracement of the
morning run, down to 103 11/32. After a bounce to the 38.2% retracement of
the intraday swing decline from the double tops, the market drifted lower
before fulfilling the 103 11/32 objective mentioned above. These chart
points are mentioned here as a possible way to trade bonds intraday.

Also in debt futures, 10-years
(
TYU1 |
Quote |
Chart |
News |
PowerRating), from the Momentum-5
List, popped open and made good on an Off The Blocks
long entry. USU1 closed up 19/32 at 103 15/32. TYU1 gained 12/32 to 105
20/32.

Going forward, the most accurate predictor of the
Fed’s likely rate actions, Federal Funds futures contracts, are not pricing
in a for-sure cut until September. Why? For the August
meeting, the
(
FFQ1 |
Quote |
Chart |
News |
PowerRating) is pricing in a 56% chance of a move to 3.5% from
its current 3.75%. For September
(
FFU1 |
Quote |
Chart |
News |
PowerRating) there is a 98% chance of a
25-basis-point cut. The rate cut looks like a sure thing by early autumn.
And by later this year, both November
(
FFX1 |
Quote |
Chart |
News |
PowerRating) and December
(
FFZ1 |
Quote |
Chart |
News |
PowerRating)
are estimating even-odds of another 25-b.p. cut to
3.25%. But that’s it; then right away next year, subsequent-month Fed Fund contracts are saying the Fed will tighten back 1/4% to 3.50%.

This sets up a potential trade. If the Fed is going to continue easing rates,
why won’t it proceed using its professed gradualist approach and hence, do so by
cutting a 1/4-point at its August meeting rather than later in the year. The
August Federal Funds futures
(
FFQ1 |
Quote |
Chart |
News |
PowerRating), at their highs today at 96.354, priced
in only a 48% chance of such a rate cut to 3.50% by the Fed’s August
meeting.

Let’s look at this through a very short-term retrospectoscope and remember that
everyone, especially Kudlow, was whining that the Fed wasn’t doing enough to
stimulate the economy by slashing 50 bp. At the July FOMC meeting, there were
much higher hopes, an 80% chance, for
a move to 3.50%. But it didn’t happen. In July, this market way overestimated
the Fed’s easing aggressiveness, and when they cut only .25% (again, the market
priced in an 80% chance of a 50-b.p. cut), the then nearby July contract
(
FFN1 |
Quote |
Chart |
News |
PowerRating) tumbled. Now it appears the market is underestimating
the Fed and its professed gradualist approach. Does this sound like one of the
Masters, Soros, talking about overshoot and the reflexivity in the markets? It
does to me.

This implies that August Federal Fund futures
(
FFQ1 |
Quote |
Chart |
News |
PowerRating) will move from their
current 96.345 to 96.500, if the Fed maintains its
gradualist easing course and cuts 25 points at its FOMC meeting in a few weeks.
(Go to the Futures
Tools Page to see the Contract Specifications of this contract called
“30-Day Interest Rates”). One final technical note on the FFQ1. It
broke out of a complex, or two-step, pullback from a one-month high today.

Kudos, again, to Carolyn B for pegging the swings in the spooz in her
S&Ps and Nasdaq Price Action Levels. By this I mean she alerted
subscribers — before the
(
SPU1 |
Quote |
Chart |
News |
PowerRating) arrived there — to the high of the
session, to the low of the session, and to the late afternoon swing low within
1.60 or less. Impressive.

August pork bellies
(
PBQ1 |
Quote |
Chart |
News |
PowerRating), now the Momentum-5
List leader, have provided Off The Blocks
entries for the past two days. As mentioned in recent commentaries, bellies have
exhibited powerful momentum recently and cold be legging higher in just leg
three of a potential five-wave Elliot Wave pattern.

August lean hogs
(
LHQ1 |
Quote |
Chart |
News |
PowerRating), also qualify as a momentum market due to
their standing on the
New 10-Day Highs List and also made good on an Off The Blocks
entry and approached a new contract high.

How To Play The Fed

BUY THE FEAR, SELL THE GREED

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