The Fed for Fun and Profit

If you have followed my commentary you know I am an avid "Fed Watcher", and that I believe the actions of the Federal Open Market Committee (FOMC) have been both ill conceived and ill timed due to a bias towards inflation fighting. Even in the statements of it's chairman and members espousing the need to keep the policies of quantitative easing in place the specter of upcoming inflation is always the next sentence. Sadly this collection of like minded individuals has resulted in a self reinforcing feedback loop of policy actions that have been a day late and a dollar short throughout the current economic debacle. Like Quixote they tilt at the inflation windmill, with Mr. Geithner and his predecessor Mr. Paulson their Panza, and the congress their Rocinante. Sadly the comparisons to Cervante's immortal work do not end there, as the role of the wealthy patrons who's cruel practical jokes lead our hero into a great melancholy in the end are being played by the captains of industry in the form of the Goldman Sachs's and the J.P. Morgans. The Feds banners of chivalry are tattered and threadbare U.S. Currency notes whose value has been under assault by the policies they have engaged in.

As a lover of good literature, and fan of both comedy and tragedy in the classical sense, the actions of the Fed and its constituents has provided a cinéma vérité  which has evoked strong emotions. Time and time again I have been surprised by the single mindedness of their approach, amazed by the seeming inability to acknowledge or correct their own mistakes, and their steadfast attachment to their anti inflation bias. No series of events nor results of their policy actions can sway them from their course.

That's the fun part, how can we profit from it?

First, we must realize that the Fed will continue to be what they are, and that will cause them to make the same policy blunders they have made in the past. Where they were slow to realize that inflation was not the biggest threat on the way down they will be too quick to fight it on the way up. Already they are showing their hand with talk of "reverse repo's" and "raising rates sooner rather than later".  Their slow witted allies in Congress and Treasury will no doubt act as Panza did in facilitating these actions.

Second we will need to be positioned to take advantage of two things, one is to be ready when they stop the quantitative easing, and two is when they begin the fight against inflation.

Let me step out for a second and talk about a policy that will reinforce the feedback loop I mentioned earlier. The Fed is the principle buyer of Treasury Securities at the moment, especially the Long Bond (30yr). This is keeping the price unnaturally high, but as Todd Sullivan ( http://www.valueplays.net ) has said, "a juggler can't go on forever". At some point they will have to stop propping up the price of the long treasuries, possibly very soon indeed as auctions of the shorter term paper resulted in a spike in the long bond yield this past friday may be indicating they are easing their purchases. Rising yields in the long bond will be taken as a potential inflation indicator which will then spur the FOMC to remove even more stimulus and the ferris wheel begins turning.

How can we play this? Here are my suggestions:

1) Stay short the long treasuries. You can be long the ETF TBT or use Futures if you trade these products

2) Continue being short the U.S. Dollar versus the currencies of the commodity based economies like Australia and Canada

2) Be long the commodities themselves. Copper, Precious Metals (Platinum and Silver are my favorites but I am long Gold on technicals as well), and Oil

Technical Traders will speak of momentum and trends. If these concepts can be translated to this context I would be short the Fed due to a strong trend towards wrongness and powerful momentum pushing them to continue their methodology.


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