We're all Fed Watchers Now

By
A A A

By Greg Jensen

There seems to be two distinct opinions of Ben Bernanke. He is either a hero who saved America’s economy, or he is a reckless man, playing fast and loose with our economic future. History will decide, but for those of us that follow the markets, there is one thing for which we should thank the Fed Chairman. His tenure has seen at least some degree of transparency in the Fed’s actions.

Not that long ago, “Fed Watcher” was a viable career choice for young economics graduates. Every financial firm had a person whose job it was to scour the text of any press release or minutes, looking for hints as to the Federal Reserve’s thinking and possible action. There may still be some who do that, but the need has been reduced under Bernanke’s reign. Regular press conferences give us all an idea as to what the mood of the meetings were immediately after them, and policies, such as QE 1, 2 and 3 are usually telegraphed and discussed in advance.  The latest press conference confirmed the Board’s intention to continue buying back $85 Billion of Government debt each month.

Whether you believe continued action is an example of Federal overreach or a necessary evil, the fact is that it is going to happen. What we, as investors must do is attempt to read its effects. There is little doubt that at least part of the stock market’s buoyancy is down to the amounts of cash being pumped into the financial system. More interesting in many ways, however, is the effect of the Fed’s policies on the market they are actually manipulating, bonds. The stated aim of QE is to lower long term interest rates. This has been successful, pushing the 30 Yr Treasury rates to around 2.5% until the last few months. It is this recent recovery in rates (and hence the drop in prices) that interests me. Prices ticked up on the latest announcement, but there was no significant move. The market didn’t seem too worried about being caught short.

 

The chart above is for the i-Shares Barclays 20+ Year Treasury ETF (TLT) which seeks to replicate that long-term bond index. As you can see, prices have been in a downward trend since August.

If prices can fall fairly sharply, despite a buyer of $85 Billion per month of Treasuries being ever present, what does that tell us? To me, it hints at trouble to come. A coherent exit strategy is becoming more and more difficult to envisage.

The next question, then, is what to do to position yourself in order to benefit. Either shorting TLT or buying puts on the fund would be one option. If you are more aggressive, you could look at its leveraged opposite, the ProShares Ultra Short 20+ Year Treasury ETF (TBT). Leveraged ETFs are designed as short term hedging instruments for traders and usually don’t suit long term investors. Maintaining a small position as a hedge, however, could be wise. Some may prefer to buy gold, maybe through the ETF GLD. This would work should rates rise in response to inflation, but I believe they could do so without any marked increase in the PPI, so would prefer a purer play.

The problem in this case is timing. Long-term rates are bound to revert to the mean at some point as negative real returns aren’t sustainable, but there is no guarantee it will be soon. You have to be prepared to lose in the short term, but it may well be worth the risk as it seems that the Fed’s buying is now being absorbed.

The Federal Reserve is more open now about their intentions than they have been in the past and we no longer need specialists to predict what they will do. Given that, the market move against them should be taken as a warning. Taking on some kind of hedge would seem prudent.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Economy , ETFs , Investing Ideas

Referenced Stocks: GLD , TBT , TLT

OptionsANIMAL

OptionsANIMAL

More from OptionsANIMAL:

Related Videos

Stocks

Referenced

Most Active by Volume

56,834,794
    $15.52 unch
47,736,761
  • $94.72 ▲ 0.83%
41,992,984
  • $2.47 ▲ 11.76%
40,893,734
  • $34.7901 ▲ 2.14%
39,324,803
  • $69.27 ▼ 0.19%
39,276,613
  • $7.28 ▲ 2.68%
39,084,483
  • $44.83 ▼ 0.01%
33,527,212
  • $26.02 ▲ 0.15%
As of 7/22/2014, 04:03 PM