In widespread anticipation of the Fed broadening its accommodative stance, the dollar poked down through its proposed (white) channel overnight.

While the EURUSD is back-testing its recently broken rising channel.

With expectations high that the Fed and Congress (some of you might have heard recent talk about the so-called “fiscal cliff”) will deliver, the cost of any disappointment could be very high indeed.

The Fed is expected to replace the upcoming expiration of Operation Twist with new bond purchases, bringing the monthly total to $85 billion (including MBS.)  Whether QE was worthwhile or not is a question for future history books.

But, there’s no question that each round has resulted in diminishing returns for the market — witness QE3’s paltry 40-pt gain on SPX.  Unfortunately for the Fed, they were up against a worthy foe — a well-established Bat Pattern that snuffed out the rally as we expected [see: The World According to Ben.]

After the subsequent 130-pt decline, SPX is almost back to its pre-QE3 price level. I find it interesting that, yesterday, 60-min RSI tagged the top of the channel line formed from that brief rally.  It’s all the more interesting that it did so in the form of a back test of the channel that contained the rally from 1343 — and failed to break the previous (Nov 2) high of 1434.27.

continued for members…

The daily RSI chart presents a good case for the downside.  RSI broke down from the rising white channel on Oct 18 and has been in back test mode ever since.  On the other hand, RSI also broke out from the falling red channel on Nov 28 and subsequently back tested on its way higher.

The next few sessions are critical, as we have to consider the possibility of an expanded channel — though our forecast calls for the latest back test to fail and turn south.

UPDATE:  12:15 PM

If the Fed news is very positive, i.e. net more printing, I expect at least an intra-day breakout to the .786 (1446.44) or even .886 (1459.56) of the 1474-1343 decline.

If it’s negative, i.e. no replacement for the expiring Twist, the downside should be swift and severe.

What if it’s somewhere in the middle?  I think the upside should be limited to either the .786 or, secondarily, the .707 (1436.08.)

The Fed has dropped plenty of hints about not removing stimulus at this point.  But, might they play a little hardball, just to “encourage” Congress to act?  We’ll find out soon enough.

UPDATE:  12:30 PM

Pretty much as expected, except for the “25 bps fed funds until unemployment is below 6.5%” part.  I’m playing along on the upside with initial target the .707 at 1436.08.  Again, likely ultimate target is the .786 at 1446.  Charts in a few.

UPDATE: 1:30 PM

Target looks like 1439.49, but I’ll close longs here at 1438.  Now, all short.  Charts below.

UPDATE:  2:15 PM

EURUSD just completed a Bat Pattern at its .886, with 60-min RSI also completing a back-test and channel top tag.

Here’s the long view:

UPDATE:  3:15 PM

Various indices showing a top…  Many Gartleys that had completed a day or two ago at their .786’s just completed a Bat Pattern at the .886.

XLF extended its Gartley to a Bat, failing (so far) at an important channel line.

The DJIA reversed at an important channel line (as well as a .707 Fib).  Next stop could be as low as 12,035 depending on how long it takes.  Best estimate: Jan 11-16.

COMP could go a bit higher, say 3048.  But, the bigger move is down to the mid 2700’s around year end.