Bullish Speculators Will Get Flushed Out Ahead of the FOMC Wednesday

Posted 9:45 AM ET - Last Friday the market poked below horizontal support at SPY $199. This is a critical level because it represents the breakout in August. Bullish speculators who bought the breakout are on the verge of getting flushed out. I believe we will see nervous price action ahead of the FOMC on Wednesday. This is a binary event. Either the Fed will remove the phrase "considerable time" or they will leave it unchanged. The outcome will result in a sustained directional move. A number of news sources I rely on feel that the phrase will be removed and the Fed will add new language to soften the blow. This scenario will lead to a selloff and the SPY will test the 100-Day MA. Bullish sentiment is very high and a decline would be healthy. I would welcome this outcome. Easy money has not stimulated economic growth and the punch bowl needs to be taken away. We are five years removed from the financial crisis and economic conditions are improving. From a trading standpoint, we don't want to be handcuffed by Fed Speak. If they don't remove the statement now, traders will react to every word in every press release until they do. Even if the Fed advances its tightening timeline, I don't believe rates will spike. Most of Asia and Europe are experiencing disinflation and that reduces the upward pressure on interest rates. Inflation is also low in the US. Secondly, central banks (ECB, PBOC, and BOJ) are easing. Global interest rates are low and this will also keep our rates from jumping. Finally, every time there is a small credit/geopolitical issue, we see a flight to safety into our bonds. Earnings have been excellent and the market will be able to shoulder higher rates as long as the move is gradual and as long as economic growth remains intact. China's industrial production came in a little light this weekend (6.8 versus 8.8). Retail sales, housing and direct foreign investments were little light as well. Asian markets traded lower on the news. I bought puts last Friday when the SPY traded below $199. I used 20% of my normal trade allocation and my size is relatively small. I will use SPY $199.50 as my stop on an intraday basis. I want to see follow-through immediately. If the position goes my way, I plan to be out before the FOMC statement. We should see nervous trading ahead of the FOMC statement on Wednesday. Bullish speculators will be tested now that the breakout is being challenged. We could hit a small air pocket today or Tues as they exit. If by chance the Fed leaves the phrase intact, the market will rally back to the highs. Resistance will be strong and traders will wonder if the language will be changed in October when the bond purchase program ends. I would be inclined to short a blow off rally when it stalls. Be flat into the release. We will have time to gauge the reaction and enter a trade on Thursday. . .

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