Expect Fed Intervention Soon

May 28, 2009 · Posted in Weekly Posts · Comment

Talk has been on interest rates and the bond market of late. Specifically, the market is choking under an overhang of supply from our government as well as rapidly increasing corporate issuance. The Fed’s strategy of buying up mortgage backed debt and US Treasuries is not working. There is simply too much supply at the moment and for the foreseeable future for the Fed to soak up all of the excess if they stick to the levels of debt buying they have previously announced. Clearly, the Fed and the administration both have committed to getting the housing market functioning again and to getting the economy up and growing again. Rising interest rates do not help that process. Indeed data released today indicate that mortgage delinquencies are rising strongly again which means that another wave of foreclosures is in the offing with the knock-on impact to the banks and the economy. What to do?

We do not believe the Fed will stop here and simply say “of well we tried and it didn’t work”. Rather we think it a virtual certainty that they will shortly announce a significant increase to both their mortgage backed debt purchase program and to their quantitative easing strategy. The immediate effect of this will be to flush-out market participants who are short bonds forcing them to cover their positions. Bond rates will fall sharply on the announcement (as they did in March…we remember…we were short bonds at the time), the dollar will drop further, gold and commodities will rise, and the stock market, again re-assured of continuing reflation will rise sharply. Indeed, depending on timing Fed intervention in the very near future could be exactly what the US stock market needs to push it out of the current consolidation and into a determined move higher.

Now, should the Fed do what we expect this is nothing to cheer about longer term. It makes the dollar’s demise more likely, is hugely inflationary and, we believe, will convince even more investors, at home and abroad, that the US monetary and fiscal position is untenable. Long term this is a bad strategy. Short term it will work wonders in some markets so the trick is of course to be on the correct side of the trade.

That said, what can we say about the market’s action today? Oil rallied strongly as OPEC stated they were keeping their cuts in-place with no changes, and the weekly EIA report showed crude inventories dropping nicely. crude is now in the $65 a barrel range and will likely move towards $75 - so about a 15% move to come. Copper rebounded, the miners did well, and precious metals and their miners did well. technically, we are still in the consolidation region but we are getting close to where a breakout could occur. Stated another way, the Fed announcing increases to heir purchases now sees the market’s perfectly poised to react positively to the announcement. We’ll see what happens.

We posted The Strategic Portfolio Monday. The Strategic Portfolio is how we are investing in the global trend of dollar depreciation and Asian recovery and trading around that trend to ensure we stay profitable. Take advantage of the Free Two Week Trial and read it. We have also update the scorecard for today’s action.

The Strategic Portfolio

Portfolio Scorecard 05/28/2009

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The following additional posts are highly relevant:

The Strategic Portfolio

The Most Important Question Facing Investors

How the US Dollar Will Lose Reserve Status

Chinese Gold British Debt

Brazil

China Part 4 - Playing the Dragon

China Part 3 Global Hard Assets

China: Part 2 - Bonds, Dollars, and Inflation”.

“The Fed and The Bond Market - Will Intervention be Effective?”

“The Coming Bond Debacle”

Fundamental Trends