The Cheap Currency Conundrum:
(When the Fed Finally “Rescues" the Economy, Be Sure to Thank Them for a Larger Deficit, Bigger Tax Bills and a Weaker Dollar)
Today’s commentary is by Mike Burnick, The Sovereign Society’s Global Markets Analyst, and editor of Market Shock Trader.
Dear A-Letter Reader,
The Fed has certainly been hard at work trying to jumpstart gridlocked credit markets. In fact, Bernanke & Company have already used about US$430 billion worth of Treasury securities from the Fed’s balance sheet to pump liquidity into the besieged banking system.
According to Bloomberg, these “actions mean the Fed, and consequently U.S. taxpayers, are assuming additional credit risks.” No kidding. In fact, taxpayers will ultimately end up footing a much larger bill for this bailout. Mark my words.
It’s clear the Fed is desperate to solve this credit crunch market shock. They’re prepared to use any means necessary.
At Bernanke’s command, the printing presses at the U.S. Mint stand ready to work overtime, and the U.S. dollar be damned! Already the buck is caught in the crosshairs – more “collateral damage” from the credit crunch.
So just what has the Fed got to show for all this free money? So far, not very much!
10-Year Treasury Rates Have Declined (green line),
Yet Mortgage Loan Rates Haven't Followed (blue)
The Rates that Matter Most Aren’t Responding to Fed’s Easy-Money
As the chart above shows, massive liquidity injections and aggressive cuts in overnight Fed funds have done little to reduce the interest rates that matter most – consumer rates. In fact, 30-year fixed rate mortgages have stayed ominously “sticky” at high levels in spite of the Fed’s best efforts to bring them down.
According to data from Freddie Mac’s national survey, the average 30-year fixed rate mortgage has risen about two-thirds of a percent over the past seven weeks. It sits nearly unchanged since the Fed began cutting rates last September!
Interest rate spreads on mortgage-backed securities have also skyrocketed even as the Fed funds rate tumbled from 5.25% to just 2.25% in the past six months. This is throwing a major monkey wrench into the Fed’s attempt to rescue the financial sector.
The problem is there are about two million adjustable rate mortgage loans outstanding due to resets from low teaser-rates to much higher long-term rates during this year. Many of these homeowners are willing and eager to refinance to more favorable rates. But so far, lower rates just aren’t available despite the Fed’s steep rate cuts.
The Fed Eventually Wins its Liquidity War,
Leading to Fresh Profit Opportunities
From day-one, this credit crunch market shock has been all about the bear market in housing. That’s the root cause of it all. Long-term mortgage loan rates returning to “normal” would give homeowners the chance to refinance their way out of trouble – preventing many more foreclosures.
A saying as old as Wall Street itself cautions investors: “Don’t fight the Fed!” Massive central bank intervention has always worked in the past – and will inevitably work this time too – it’s just a matter of time.
Keep a sharp eye on 30-year mortgage rates. Once they decline significantly, and for a sustained period, the financial sector will finally get lasting relief. When that happens, certain financial firms could make a killing.
Inflation Expectations on the Rise as Fed Cuts Rates
Of course, another inevitable consequence of the Fed’s easy-money policy is structural inflation. Consumer prices are climbing nearly 5% year-over-year. Producer prices (which will get passed through to the rest of us sooner or later) jumped nearly 7% over the past 12 months, with energy (up 19%) and food (up 6%) leading the way.
The chart above shows that long-term inflation expectations are on the rise – getting baked in the cake so to speak. But this process is just getting underway. The inevitable consequence of this will be higher commodity prices – eventually.
Pairing Up Your Trading for Gains No Matter Which Way the Market Breaks
In recent days, commodities from gold to grains and everything in between have been hit by profit-taking. That’s not surprising because these are among the last “profitable” assets left to sell as institutional investors get hit with margin calls.
Look at a chart of nearly any commodity and you’ll see a parabolic run from lower-left to upper-right…so a correction in this asset class is overdue in my view. Ultimately, this will provide you with a better buy-point for when commodities rise again.
In my Market Shock Trader service right now, I’m focusing on ways to play the short-term decline in commodity stocks with well-timed put options. This gives my readers a handy way to hedge their investments – and earn profits in the midst of a sharp sell-off. At the same time, I’m singling out a few select call options to profit from the bounce-back rally I see coming in other stocks and sectors.
Some investors call this a “pairs trading” strategy. It involves going long (with call options) and short (with put options) at the same time – sometimes even in the same sector! I prefer to look at this as a solid all-weather trading strategy to profit from volatile market conditions.
MIKE BURNICK, Senior Editor
P.S. On Friday, March 21, at 11:00 am EDT, I’ll be sending out my next option trade recommendation to readers of my signature research investment service: Market Shock Trader. If you would like all the details on my next pick to profit in volatile markets, take Market Shock Trader for a risk-free test drive by midnight tonight.
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