Watching the Fed

Stand Pat, At Least For Now

By Bryan Bottarelli
Wednesday, March 21, 2007 12:41 PM EDT
Wed, 21 Mar 2007 16:41:00 GMT

Dear Bottarelli Research Member,

I have a number of new trade candidates lined up, but I think it’s prudent to stand pat until after the Fed announces their latest policy statement at roughly 2:15 EST.

As you know, the markets have shown the tendency to behave rather irrationally on announcement days — especially when slight language changes can cause big price swings. As a result, I’d like to refrain from issuing any new plays until we see how the latest announcement will effect the markets.

Going into today’s announcement, we have a rather unusual situation. You see, we have simultaneous signals of both higher inflation and slower growth in the coming months, which makes a strong argument for both raising and lowering rates. At the same time, growth for the fourth quarter was revised down sharply, not to mention the financial blowout caused by the sub-prime mortgage market. As a result of this mixed-bag of economic signals, the Fed will most likely continue their five-meeting pattern of holding rates steady at 5.25% — which means the language of today’s statement could be the primary directional catalyst. And since it’s anyone’s guess how this language will be interpreted, the wise course of action will simply to maintain our current positions. Once we see how the markets respond, we can initiate new trades accordingly.

From a pure directional standpoint, today’s Dow chart (represented below via the DIA) shows a bearish formation. As you can see, the red candlestick signals the inability of the Blue Chips to trade above their recent high at 124, which could spark the beginning of the third (and most violent) down-leg in our recent bearish cycle.

DIA

If we do experience weakness, one play could be put options on Marathon Oil (MRO – NYSE).As you can see by today’s chart, MRO has established what could be the beginning of a double-top formation — highlighted by the blow-off top that quickly turned into a red candlestick.

MRO

In a rather odd series of events, major oil names like MRO have been rallying while crude prices have been falling under $57 a barrel. At the same time, oil service companies have also been weak, sparked primarily by Halliburton’s (HAL – NYSE) reduced drilling forecast from yesterday. Lower oil prices and weakness in the oil service sector could easily spill over into the major oil names like MRO on any broad-based market weakness, so let’s keep that in mind for a possible play candidate.

At the same time, we could see a flight to quality in metals plays like Southern Copper (PCU – NYSE) and Allegheny Technologies (ATI – NYSE). As you can see below, both stocks have been extremely strong recently — which supports the trading thesis of holding longer-dated calls on each company. In fact, I would be comfortable establishing a call position on any near-term price dips.

PCU

ATI

But once again, let’s get a handle on how the markets react to this afternoon’s Fed announcement — and then we can formulate our trading strategy from there. Until then…

Lock and load!

Sincerely,

Bryan Bottarelli

Bryan Bottarelli
Editor, Bottarelli Research

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