Three Ways To Profit From the Fed Meeting

A Taipan Investment Research Report
By Sara Nunnally, Senior Research Director, Taipan Publishing Group

The Federal Reserve, after two days of meetings, emerged with “extensions of and modifications to a number of its liquidity programs,” said the Fed’s press release:

The Board of Governors approved extension through February 1, 2010, of the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (AMLF), the Commercial Paper Funding Facility (CPFF), the Primary Dealer Credit Facility (PDCF), and the Term Securities Lending Facility (TSLF). The expiration date for the Term Asset-Backed Securities Loan Facility (TALF) currently remains set at December 31, 2009. The Term Auction Facility (TAF) does not have a fixed expiration date.

The release also said that the currency swaps between the Fed and other central banks would be extended through February 1, 2010.

These extensions mean that while some improvement in the economy has been seen, the Federal Reserve believes that many areas of the economy will remain stressed for at least the remainder of 2009.

Maintaining Control

With extensions of liquidity programs, the Fed maintains control of banks that took bailouts… Another topic that’s been in the news, as Chairman Ben Bernanke testified before Congress about the Fed’s role in the Merrill Lynch takeover.

Bloomberg reported, “Legislators are trying to determine whether Bernanke overstepped his authority in pressuring Bank of America to complete the purchase of Merrill.”

Bank of America CEO Kenneth Lewis said that “he decided to proceed with the takeover of Merrill after regulators said they might remove management and because his company’s future was ‘intertwined’ with Merrill’s fate,” said the news service.

As the drama plays out in Congress, the Fed’s Treasury still has to convince the public it has a rein on U.S. debt.

The Fed’s Exit Strategy

Bloomberg reported, “Chairman Ben S. Bernanke has to convince investors the Federal Reserve can take back more than $1 trillion it pumped into the U.S. banking system to pull the economy out of the longest decline in more than six decades.”

That $1 trillion is like a giant tanker ship that can’t be turned around suddenly without great consequence… which has people questioning the Fed’s exit strategy.

There is a rumor that the Federal Reserve wants to start raising rates by the end of the year. Rates have effectively been held at zero since the start of the year. But raising rates may stall the greening of the economy.

The Wall Street Journal reported, “The economy is on track to contract at about a 1% annual rate in the second quarter, according to forecasters Macroeconomic Advisers. That would be the fourth straight quarterly contraction.”

Where’s Inflation?

A climb in rates would affect the number of people who can afford a new mortgage, a new car, and other areas.

The Fed’s key lending rate, reported CNNMoney, “currently stands at a target range of between zero and 0.25%. The market does not expect the Fed to hike the key lending rate, especially after a couple of reports last week indicated that inflation is not a near term concern.”

Inflation may not be a threat at present, but the $1 trillion the Fed pumped out certainly doesn’t just disappear.

And in order to fund that debt, the Fed has been selling Treasury bonds like mad.

Still Buying Treasuries

During this week, the Treasury auctioned off about $104 billion, which is a record amount.

And, according to The Wall Street Journal, the Fed “opted against enlarging its program to buy Treasury bonds to spur growth... It will proceed with previously announced plans to buy up to $300 billion in long-term U.S. Treasury bonds by autumn and up to $1.25 trillion in mortgage-backed securities by year's end.”

In fact, the Fed just bought $3.25 billion in Treasuries on Thursday, reported MarketWatch.

These efforts are meant to push Treasury prices higher and yields lower, as yields have a trickle-down effect that can seep into mortgage rates and car loan rates.

At the same time, the Fed is holding interest rates near zero because of stressed areas of the economy.

CNNMoney’s Chris Isidore wrote:

Some Fed watchers have been looking for signs from the central bank about when it may begin to unwind its positions in Treasurys and mortgage-backed securities, a so-called exit strategy from this period of massive stimulus. The Fed did not give any guidance though, saying only that it is monitoring its balance sheet and will make adjustments as warranted.

But what does this mean to regular investors?

How Can You Profit?

Adam Lass, editor of WaveStrength Options Weekly, says:

In order to finance the skyrocketing national debt, the Treasury Department is printing up additional bonds at a record setting pace. This has got buyers’ (think China here) knickers in a knot, since it lowers the value of the bonds they are already holding. Beyond that, the risk of default is starting to creep up to the point where the rating services are querying our country’s triple-A rating.

“Word coming out of the back door of the FOMC meeting has the Fed ‘doing nothing,’” says Adam.

But the fact that the Fed – after this last round of $300 billion bond buying – will halt its Treasury purchases shows that inflation worries may be trickling into the minds of the chairman.

Adam recommends that investors stick to a short-term downside philosophy.

Profit Play #1: Shorting Industry

The industrial goods sector covers a lot of ground – from construction machinery to aerospace and defense services. But the one thing uniting this seemingly diverse group is that many companies heavily rely on government contracts.

As U.S. debt climbs, belts, including that of the government, get tighter.

Companies in the aerospace and defense sector, like Honeywell International, Inc. (HON:NYSE) and Northrop Grumman Corp. (NOC:NYSE), have been either seeing their profits or quarterly revenue fall during this recession.

Both companies have seen their share prices fall more than 30% in the last year.

Companies in the general building materials sector, like USG Corp. (USG:NYSE) and Vulcan Materials (VMC:NYSE), have seen negative profit margins and quarterly revenue growth.

VMC’s share price has fallen more than 25% in the last year while USG’s share price has fallen an amazing 66% in the last year.

And yet, all four of these companies are off their lows for the year. That means if industry falls, these four also have significant room to fall.

Shorting or playing put options in this sector is your first profits play from the Fed meeting.

Profit Play #2: Short Treasuries

Can the Fed continue to sell currencies if there’s no real improvement in the economy?

Editor Harinder Singh, currency expert for the Taipan Publishing Group, says there are some good signs the economy is in recovery mode.

At the same time, though, the economy is not out of the woods yet…

Harinder writes:

I still have concerns about consumer spending, which has a bearing on employment or job growth. It appears that the unemployment rate, though a lagging indicator, has reached 10% or above in half of the states in the nation. The Empire State Manufacturing Index for June was lower than that for April. Capacity utilization for the nation’s factories is still below 70% and is not improving.

This information has a strong impact on how much debt the U.S. Treasury Department will be able to sell.

“TIC data for April,” says Harinder, “showed total net outflows of $53.2 billion, while in March there were inflows of $25 billion. Both China and Japan are reported to have trimmed their holdings of U.S. assets.”

If the world turns it back on U.S. debt, where does that leave Treasuries?

If demand slips, so do T-bills prices. There are several exchange-traded funds that short Treasury bonds that savvy investors can use to play the Fed meeting, particularly now that the Fed has said it will stop buying its own bonds to spur demand.

Profit Play #3: Short the U.S. Dollar

Executive Editor Justice Litle of Taipan’s Safe Haven Investor and Macro Trader, writes, “The $64 trillion question right now is ‘inflation versus deflation.’ Which one of them are we going to get? There are logical arguments on both sides of the divide.”

Trillions of dollars have been pumped into the system.

“In fact,” says Justice, “the European Central Bank upped the ante even further this week, with a record $620-odd billion worth of liquidity flooded into euro-zone money markets.”

All that cash can’t be taken out of the system quickly, and that leaves a massive potential for double-digit inflation, which would destroy the greenback.

“Either the global economy comes roaring back with a vengeance, or the crushing weight of debt (perhaps further weighted by a second banking crisis) spurs mass-monetization of government debt – the ‘printing of dollars with which to buy bonds,’ a phrase which by now may be tattooed on some of your brains,” says Justice.

And that means you have to short the dollar.

That can be done in a number of ways. There are exchange-traded funds that allow you to short the greenback. There are other ETFs that allow you to play puts on bullish dollar funds. See the PowerShares DB U.S. Dollar Index Bearish ETF (UDN:NYSE) and the PowerShares DB U.S. Dollar Index Bullish ETF (UUP:NYSE).

You can also play dollar-denominated assets like gold and silver, oil and grains. There are also a number of ETFs in these areas too, like the SPDR Gold Shares (GLD:NYSE) and the iShares Silver Trust (SLV:NYSE), the U.S. Oil Fund ETF (USO:NYSE), and the PowerShares DB Agriculture ETF (DBA:NYSE).

These ETFs will act as a hedge against a falling dollar.

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Originally published June 26, 2009.

Other Related Topics: Exchange-Traded Fund , Inflation , Sara Nunnally , Taipan Insider

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