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Investors Ready to Sell the News

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The stage is set for the market fret.

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The headline snuck out last night with little fanfare. In fact, if it wasn't for a late-night email from a diligent Minyan professor, I might have missed it myself. The Wall Street Journal reported that the Federal Reserve is "likely to unveil a program of US Treasury bond purchases worth a few hundred billion dollars over several months." That announcement is expected to be made following the FOMC meeting next Wednesday.

Welcome to the Goldilocks Guessing Game of 2010, which is a fitting coronation to a year that saw European Contagions, Flash Crashes, and a trillion dollar EU Emergency Fund. Given the anticipatory rally into this event, our central bank is dancing on the head of a pin. Should they administer fewer drugs than expected, investors who bought the rumor will sell the fumes. If they pull another Pulp Fiction and stab the economic patient in the heart with an adrenalin needle, it will signal that conditions are worse than expected

As I discussed on Bloomberg TV Friday, my humble view is that $500 billion in additional stimuli, as crazy as this sounds, is already baked into the cake and will likely be sold. Perhaps more intriguing, however, is the interest rate dynamic. If the synthetic sweetener is softer than expected, perception could shift towards a legitimate recovery and trigger an up-tick in rates. If, on the other hand, the market's Mia is shocked back to life, it could set the stage for inflationary rage.

While several Billionaires Have Screamed Bull by offering that either scenario will be positive for the market, I would humbly note that such a situation could catch the hedge fund community off-sides. As it stands, big money has the same bet on across the board: long risky-assets and short the US dollar, and there's a stealth short base in VXX (volatility) options mixed in for good measure.

The tape has traded great as evidenced by the 14% jump in the S&P and 20% rise in the NASDAQ since the beginning of last month, not to mention the buff corporate credit market that suggests higher equity levels. While the meat of that debt meal is sandwiched on either side by a sticky sovereign situation and still-extended consumers, perception is reality in the marketplace and we must respect that particular tea leave.

As evidenced in the chart below juxtaposing the CRB (commodities) against the greenback, however, the negative correlation bet between asset classes and the dollar remains very much in play. This has been a long-standing theme in Minyanville, "asset class deflation vs. dollar devaluation," and while it was interrupted by the European Disunion, it's back in a big way. Should that begin to unwind -- and I believe the dollar has room to run on the upside -- we could see a massive bottleneck at the exit ramp.


Click to enlarge

See both sides, define your risk and remember that when you're running with the herd, it's often difficult to see the edge of the cliff.

Good luck today.

R.P.

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