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March 28, 2006

Big Surprise

Today's post title is, of course, intended quite sardonically. Our central bank bumped up the Federal Funds rate, while indicating that more hikes will likely be needed. The FOMC gave no indication that a halt to rate hikes is forthcoming. Traders were obviously surprised and disappointed that the Fed didn't ease up on their language. Equities sold off sharply on the heels of the release, with major averages falling about 1%. However, readers of The DOCument should not find today's new surprising at all.

Metals and miners sold off after the Fed's statement, while the dollar put in a nice reversal to the upside. No doubt, giving the dollar a push is the Fed's primary objective, and for now, they are doing their job well. I will go out on a limb and state that, barring a financial crisis, we will see more of the same from the Fed in May. The FOMC knows very well that inflation is burgeoning (at their own hands), and they will delicately edge the Funds rate up until the market will simply have no more of it. They hope the measured process will allow them to take the Funds rate up to where it should be… perhaps 6-7%... but deep down I think they know they won't make it that far without instigating some sort of tipping point in the financial markets. Their gut feeling probably won't stop them from taking us to that point. Besides, the alternative of accelerated inflation is not any more palatable.

So the big question is how this scenario plays out in the market. Presently, I believe we could see a continued sell-off in equities. Traders hate uncertainty. They were nearly certain Bernanke would throw the market a bone, and now they simply don't know what to expect. Toss in fairly overbought conditions, and we have a recipe for more selling.

Metals also sell off from here, I think. Just how tough will Bernanke & Company get? No one is sure. Metals also had some expectation of easing baked in, and this premium will now unwind. Whether some other form of demand comes in to soak up that supply, I don't know, but I'm holding off on building my trading positions until I can get a solid footing. For the record, I closed the last of my Newmont Mining calls just before the Fed's statement today. With NEM shares already up a percent on the day, I didn't see much upside should the Fed ease their language, but I saw a lot of downside should things pan out the way I expected.

Housing stocks took a dive, as well. The rally of the passed few days seems to have been position building by traders hoping for an extended run compliments of the Fed. With the housing market already on its heels, the added uncertainty about the future of rates will offer tremendous resistance to the upside for this sector. Seeing these odds in my favor, I added some puts on Building Materials Holding. I intend to evaluate a couple other homeys for potential shorts, as well.

Regular readers know I've been on the lookout for a major market slump for about a year. Bear markets tend to unravel just when they are least expected, and I believe now could be one of those moments. Optimism is rampant. With every rate hike, the bulls come out and say "don't worry... the next one will be the last," and people have bought it so far. But consider that markets are overbought. Charts are toppy. Mutual Fund cash is at extreme lows. And now we have a not-so-certain outlook on rates. Granted the market has proven to be more resilient than any bear has anticipated. Perhaps Señor Bull has another wild card up his sleeve, but I hear Papa Bear grumbling for his morning cup of coffee.

Disclosure: Short BMHC; Long BMHC Puts

 

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