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Fed Incites Surprise Relief Rally

March 22, 2007

Dear Fellow Options Trader,

Ben Bernanke, the chairman of the Federal Open Market Committee, must have been in a philanthropic mood during the past couple of trading sessions. And whatever "Big Ben" was feeling must have been contagious, as a united FOMC at yesterday's meeting gave the market a significant boost. While the market was admittedly glad to see the Fed Funds rate hold steady at 5.25%, it was what the Fed didn't say that made investors rejoice!

Yesterday (March 21), we had a TV crew in our office to watch and film us ahead of the Fed meeting. I told them we expected the FOMC to hold rates steady, as that's what the men and women who trade at the Chicago Board of Trade had indicated.

It wasn't the BOT traders' words, but instead their actions, that told us what the Fed would do. How? By putting their money where their mouths were through trading the Fed Funds futures contract. They accurately predicted that there was a 98% chance that the FOMC would do what it did, which was to leave rates unchanged.

Since you and I like to play the odds (and not against them), it's usually a pretty wise play to bet on the side of the overwhelming majority in the futures pits!

I had another prediction that I shared with the film crew, although I didn't have the benefit of seeing what BOT members thought. My expectation was that the Fed would mention the subprime issue, and estimate its economic fallout potential.

TELLING TIME

Sure enough, you could have set the atomic clock by the release of the FOMC decision, which came as it always does at 2:15 p.m., and traders' reactions were immediate. As my friend Peter McKay of The Wall Street Journal quoted me saying, "A roar went up on the trading floor when people saw the Fed's statement."

The reason for the roar was not because the Fed left rates unchanged, as that was almost as anticipated as Britney Spears' return to rehab! Instead, the impetus for the excitement was because the FOMC didn't utter a single sentence about the subprime markets.

The Fed didn't make much of a comment about housing, and it saw fit to totally leave out the subprime issue. In fact the FOMC's comments about housing were the following seven words, "Adjustment in the housing sector is ongoing."

This, my friend, was the red cape that was waved in front of the bulls yesterday and the primary catalyst for yesterday's 160-point rally in the Dow.

In fact, it was the financial stocks that were first to react to the Fed's non-move/non-mention, and as you can see from the graphic below, Bank of America (BAC) took off to the upside as soon as the news broke.



Similar rallies accelerated in Morgan Stanley (MS), Citigroup (C) and the subprimes, Accredited Home Lenders (LEND) and Fremont General (FMT).

The other tidbit that I gleaned from the FOMC meeting was that Chairman Bernanke seemed to be earning street cred, thanks to gathering consensus from an otherwise-disparate group of Fed governors. This was one of the questions the Street always had about Big Ben, and I think that, like the Fed Funds traders at the CBOT, the Fed chairman put his money where his mouth was and lived up to expectations!


Jon "Doctor J" Najarian
Editor
ChangeWave Options Trader