As a technical trader, I grossly dislike the Fed.
I’d prefer to focus solely on my charts, but unfortunately, these days, more eyes are on the Fed than ever.
But I have a solution to this problem — one that’s already helped quite a few of you make money.
Every six weeks, the Fed meets and decides whether to lower or raise interest rates.
The rest of the market is stuck waiting for the official announcement.
This can be painful and it’s one of the main reasons markets have been so emotional lately.
Fortunately, I’ve found a way to gain insight into the Fed’s next move — and potentially get in position to profit…
Right now, markets believe the Fed is going to accelerate its tightening of the money supply. This has markets spooked.
But this chart is showing me something different.
It tells me the Fed will soon pause its tightening of the money supply.
That means they’ll raise rates less than expected or slow the pace of their balance sheet drawdown — and we’ll have a chance to jump into more puts on the iShares 20+ Year Treasury Bond ETF (TLT).
Several of you have told me you made triple-digit gains on the puts I recommended last year.
I’m not surprised. Rising rates are bearish for bonds, so put options on TLT were all but guaranteed to deliver.
And they will be again soon.
How can I be so certain? It all comes down to this chart…
Get Ahead of the Fed With Momentum
This has to do with the momentum of unemployment — specifically, the momentum of unemployment insurance claims and how it relates to the Fed Funds Rate.
I touched on momentum earlier this week. It’s one of the most powerful forces in the market and you can use it to predict all sorts of things, including decisions the Fed makes.
It’s the Fed’s job to maximize employment, stabilize prices, and promote moderate long-term interest rates.
However, for the past few years, the Fed has seemed most focused on maximizing employment. They’ve allowed inflation to rise in order to keep unemployment low.
At this point, low unemployment is practically embedded in Fed policy.
In other words, it’s their “tell.”
Every week, the number of initial claims for unemployment insurance is released. This gives the Fed an idea of how many people are losing jobs each week.
Now for the chart.
This Chart Doesn’t Lie — We Can Predict the Fed
People say it’s impossible to predict what the Fed will do next.
This chart disagrees.
As you can see, there is a clear, indisputable, and inverse relationship between rising claims and interest rates:
This is a chart of the early 1980s, when the Fed raised rates high enough to end double-digit inflation. The popular stochastics indicator I showed you on Tuesday is at the bottom.
In this case, it’s measuring the momentum of new claims. Remember, momentum leads trends. So as momentum rose, new claims also rose. As momentum slowed, so did unemployment claims.
And each time, the Fed had a predictable reaction….
When unemployment claims went up, the Fed eased up on interest rates. And when the momentum of claims slowed, the Fed pushed rates back up.
Now, this was a different time. The Fed more actively managed rates a few decades ago.
Today, rate changes tend to occur only at Fed meetings, which are scheduled every six weeks. To see what the Fed will do at these meetings, we need to watch the current momentum of new claims.
This is shown in the next chart:
As we’ve established, the Fed waits for momentum in new claims to drop before raising rates.
Right now, momentum is low but pointing up. If we see a jump in momentum, expect the Fed to pause its tightening.
This will allow us to get ahead of the Fed and jump into puts on TLT. Those puts will gain when momentum drops again, and the Fed resumes tightening.
I’ll be watching this chart weekly, and will update you as I see opportunities.
Michael Carr, CMT, CFTe
Editor, True Options Masters
Chart of the Day:
This Sentiment Gauge Tells Me New Lows Are Coming
By Chris Cimorelli, Chief Editor, True Options Masters
Mr. Merson is out so I’m filling in for today’s chart of the day.
Like Mike Carr, I hate paying attention to the Fed — but I have to because others do.
It’s the same reason I pay attention to sentiment indicators. I don’t care how other traders are feeling, but knowing their levels of fear and greed help me stay one step ahead of them.
For that, I use CNN’s Fear and Greed Index. The index dropped to an extreme low in mid-March, which is how I was able to predict the near-term bottom before markets reclaimed more than half of their losses.
The Index has two views — the dial (above) which provides an overview and the historical levels (below).
The bottom in March coincided with stock prices. While markets are retesting price lows from March, as you can see, sentiment is not. In fact, it’s only slightly below where it rose to at its recent near-term high earlier this month.
This makes me think more lows are coming. Fresh new fears will push prices lower.
But we want to hear from you.
Will new lows confirm a longer-term bear market? Do you think the bull market from the past two years is still on? Or is it too soon to call?
Let us know by voting alongside your options masters in the survey below…
Chief Editor, True Options Masters