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It's a basic reality of the markets that sometimes they overshoot. It doesn't always happen, and the overshoot isn't always severe. But anytime fear or greed kicks in, look for markets to become overextended, either up or down, and look for the opportunity to go against the crowd and buy or sell into the fear or greed.

The prevailing market paradigm -- one characterized by fear -- could spur an overshoot situation in a futures market you may not normally take positions in: federal funds futures. Terrorism warnings, escalating tensions in Southwest Asia and the Middle East, battered confidence in corporate accountability and declining stock prices (the Nasdaq 100 has already undercut its post-9/11 lows) are contributing to a view that the

Federal Reserve

will keep short-term rates at their current, 40-year low of 1.75% for a longer period than previously expected. But for how long?

Let's take a look into the not-too-distant future. The Federal Reserve will

meet five more times this year. The chance of a rate cut at its next meeting on June 25 is practically nil. You can see this by looking at the nearby

July federal funds futures

contract (FFN2:CBOT), which is pricing in only a 6% chance of a 25-basis-point rate hike to 2%. (Click

here for information on the contract and how to calculate the implied rate).

One week before a Fed meeting, the nearby fed funds futures contract is one of the most accurate predictors of the Fed's rate moves. But subsequent back-month contracts are less accurate at predicting what the Fed will do, and they often make large adjustments, reflecting changing economic conditions and perceptions before expiring.

The Fed then has meetings in August, September, November and December. Last Friday, when the Nasdaq 100 undercut the September '01 lows and the

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S&Ps

(SPU2:CME)

dipped into triple digits , the

October fed funds

contract(FFV2:CBOT) priced in only a 36% chance of a quarter-point hike to 2%. The market moved off its contract highs on Monday, indicating a higher likelihood of a rate hike, but this morning, following a tame consumer prices report, the October contract is again trading near Friday's record, at 98.16.

The Trade

The trade is based on the idea that the market is focusing excessively on the fear factor and misreading or ignoring economic signs that suggest the Fed will raise rates by the Sept. 24 meeting. Why will the Fed raise rates? Because the economy has started recovering, despite the recent fear spawned by geopolitical uncertainty. Factory orders have been up for five consecutive months, unemployment is edging lower, construction and home sales remain firm, and GDP surged ahead 5.6% in the first quarter.

The Fed will also be on the lookout for signs of inflation, which are stealthily appearing. As Tony Crescenzi

pointed out on Friday, core crude goods, a component of the producer price index, increased a sharp 3.4% following a leap of 3.6% in April, one of the biggest increases on record. (Core crude goods are products entering the market for the first time that have not been manufactured, raw materials such as raw cotton, coal and iron.) Once the uptick in core crude goods translates to higher finished goods and consumer prices, the Fed will tap the brakes and begin raising rates.

If the Fed raises rates 25 basis points to 2% by September, the October fed funds contract will drop to 98.00 (100 - 2.00 = 98.00). A short sale at these levels with a protective buy stop-loss set just above the 98.16 high at 98.17 -- three ticks -- sets up a reward-to-risk profile greater than 4 to 1, and the opportunity to sell into excess fear.

Marc Dupee is an independent trader and co-author of the book

The Best: Conversations With Top Traders. Dupee was formerly markets analyst and futures editor for TradingMarkets Financial Group. At time of publication, he held no positions in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While he cannot provide investment advice or recommendations, he invites you to send your feedback to

Marc Dupee.

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