What to Do as the Fed Plays Ostrich

The latest Federal Reserve meeting came and went this week. And I gotta tell you, the Fed should replace the eagle on its website with an ostrich!

I say that because the post-meeting statement was a bunch of boilerplate text. No recognition of rising inflation pressures around the world. No recognition of an improved tone to the economic data. And most importantly, no acknowledgement whatsoever about the dismal failure of QE2!

I can’t change what Fed officials are going to do or say. Neither can you. But as investors, we CAN take steps to protect ourselves from their “see no evil” approach to monetary policymaking.

I’ll share some thoughts on how this week. But first, I want to talk about …

The Stunning Disconnect Between the
Fed’s Words and Economic Reality

After reading the Fed’s statement on Tuesday, I couldn’t help but wonder what planet Bernanke and his buddies are living on. Just consider the following:

The Fed SAID that inflation expectations were “stable” …

But the 10-year TIPS spread, a key market-based indicator of inflation, just blew out to 232, its widest since May. The spread measures the difference between yields on Treasury Inflation Protected Securities and traditional Treasuries; the wider it is, the more future inflation the bond market is pricing in.

The Fed SAID that we still have “price stability” and that “measures of underlying inflation have continued to trend downward” …

The Fed said prices are stable. But many consumers would disagree.

But the November Producer Price Index (PPI) for finished goods surged 0.8 percent, almost double most economists estimates. Moreover, the inflation is not stemming just from rising energy prices. Overall, the cost of food rose 1 full percentage point in November, equivalent to 12 percent annual inflation. Egg prices led the way higher, jumping 23 percent in November, while the price of fruit jumped an astounding 14 percent.

Think these are one-time, freak price jumps?

Think again, because since the first of this month… the price of corn is up more than 3 percent … coffee is up more than 8 percent … sugar is up 8.49 percent … oats are up nearly 6 percent … while cotton prices are up more than 16 percent — all of this in just 15 days!

The consumer price index hasn’t started jumping yet. But just like night follows day, it will as companies pass on higher wholesale costs.

The Fed SAID it would continue its QE2 policy, saying it would “promote a stronger pace of economic recovery” …

But that reckless policy is driving interest rates skyward!

In fact, two-year Treasury yields have doubled in 29 trading days. Five-year yields have surged 102 basis points, or 1.02 percentage points, while 10-year yields just hit a seven-month high.

What’s more, thirty-year municipal bond yields soared to a 16-month high, as thirty-year mortgage rates jumped to the highest since the tail end of the spring home buying season.

So not only is the Fed failing to promote recovery by driving borrowing costs down. It’s actually hindering the recovery by driving costs up. Yet in the Fed’s fantasy world, everything is peachy keen!

Four Strategies to
Mitigate the Damage

With interest rates rising and the Fed continuing to print money and buy bonds, despite a zero percent success rate so far, how can you protect yourself?

First, avoid long-term bonds of almost any kind. The longer the maturity on a bond, the more sensitive its price is to interest rate fluctuations. The surge in rates we’re seeing is crushing bond investors and the pain will only get worse the higher rates go.

Bonds from select South American countries are a good alternative to Treasuries.

Second, consider foreign debt as an alternative to U.S. bonds. Many foreign countries are in better fiscal shape than we are. The European PIIGS nations are an obvious exception. But in places like South America and Asia, opportunity abounds. Explore some of the exchange traded funds (ETFs) and mutual funds that invest there, focusing on shorter-term securities.

Third, to hedge your interest rate risk, consider inverse ETFs that RISE in value when bond prices FALL. You can even buy exchange traded notes (ETNs) that allow you to profit from a steepening in the yield curve, like we have now.

Fourth, remember that all bond market meltdowns present opportunity. If you sidestep the price declines — then scoop up bonds when their prices are cheap and their yields are high — you can lock in hefty returns for the long-term. That’s what I plan to do at the right time, and I recommend you do too!

Bottom line: You may not be able to pull Bernanke’s head out of the ground. But you’re not defenseless against his ostrich-like behavior either.

Until next time,

Mike

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