The Fed playbook for 2009

My last and most important class of the year will be held on Wednesday, November 19th from 6-9pm. I will discuss the best and safest places for your hard earned $$$ and give a detailed forecast for interest rates and the economy in 2009. Can you really afford not to be there?

I have spent more than 40 years studying Federal Reserve monetary policy and carefully monitoring the remarks of Federal Reserve Chairmen. We are at an extraordinary juncture in economic history that demands correct decisions be made for the survival of this country (and much of the world). Our current Fed Chairman, Ben Bernanke, is clearly the world’s expert on the Great Depression and it is no coincidence that he is leading us through this very difficult time but what is unique is that he spent years writing about what would be needed when we entered another crises similar to the 1930’s. I have been fortunate and lucky to have forecast (see archives) much of what has taken place in the real estate and credit markets this past two years. Rarely does a team get the opportunity to view the opponent’s playbook BEFORE the game begins but that is exactly what we have today as all of Bernanke’s writings are easily accessible on the internet.

I urge all readers to take the time to read and re-read a speech Ben gave on November 21, 2002 titled “Deflation: Making Sure it doesn’t happen here.” It’s only 12 pages but pay special attention to page six where he begins by asking the question: What should the Fed do if its overnight funds rate falls to zero? With this week’s 50 basis point cut to 1.00% it is only a matter of a few months before we land at 0.00% and the focus shifts to long-term rates. Lower interest rates usually stimulate loan demand but not if price levels are declining in a Deflationary environment. When asset prices are falling any level of positive interest rates is too high and creates high “real” interest rates which discourage borrowing. Bernanke suggests two ways to lower long-term interest rates, with an announcement that rates will remain at zero for a number of years thus changing investor expectations to the new lower level. The second method involves the Fed creating a rate ceiling for long maturity Treasury bonds which would create demand whenever market rates came near this new level. The Fed did maintain a ceiling of 2.5% on long-term Treasury bonds for almost a decade in the 1940’s. Finally he suggests that if the previous two methods did not stimulate demand the Fed could purchase securities (mortgages, etc) in the market place which would surely drive prices higher and yields lower. He is the exact opposite of our former Fed chairman (Greenspan) who went out of his way to conceal his plans and felt that surprising the financial markets resulted in better execution for the Fed. Ben’s strategy is to inform in advance market participants and have them better prepared for the coming uncertain times. He is well aware that investors only see the future from their own experiences and because he did not experience the Great Depression he did the next best thing and studied it for many years. His papers were written at a time when the last thought on everyone’s mind was a repeat of the 1930’s and his conclusions are well thought out and should prevent a lengthy setback for the U.S. economy. This is the playbook for the next 12+ months of Fed policy and is much simpler to read and understand than listening to the “always bullish” experts on business television shows. The buy and hold forever theory of stock investing has allowed many investors to lose 30-40% of their hard earned portfolio dollars this year and all because their advisors don’t believe in stop losses. Every investor must take responsibility and not assume everything will always be ok.

Long-term interest rates

The U.S. 10-year Treasury closed this week at 3.96% as sellers exited “flight to quality” positions entered earlier this month and began to nibble at stocks afraid they would miss the next big rally. The key inflation component fell to 83 basis points and with Deflationary CPI numbers on the way should fall close to zero in the next few months. As long as this key Fed indicator remains below 1.00% we should see foreign buying of long-term Treasuries anytime the 10-year rises above the 4.00% level. The Fed’s next mission will be to manufacture lower long-term rates and if necessary will enter the marketplace next year with purchases. (see above). Homeowners will not see relief until house prices stabilize (2010) but can be helped immediately by lower long-term interest rates.

TIPS

A few times each year I use the term “back up the truck” because it is an expression that implies great certainty and no one can be 100% sure of any investment idea (always use stop losses). Early this year (see archives) I strongly urged readers to bet on a widening U.S. yield curve (2yr-10yr) and it rose from 108 basis points in early January to today’s level of 240 bp. This was an easy call as it was obvious the Fed would ease short-term rates throughout the year. I also forecast a much weaker British Pound this year and it has fallen over 20%. It’s time for another back up the truck call and it involves U.S. government TIPS (Treasury Inflation Protected Securities). Due to rising fears of a U.S. default on its debt the 10-year TIPS notes have seen their yield rise to 3.13% a level not seen in many years. These notes also pay an annual amount of interest equal to the inflation rate and are usually purchased as a hedge against future inflation. They should ONLY be purchased in retirement accounts and NEVER leveraged but are a fantastic purchase despite the fact I don’t see any inflation for the next few years. Their yield is usually tied to expectations of future growth in the U.S. economy but a rising default premium make them a must for everyone’s IRA, 401k, pension or profit sharing plan or other retirement vehicle. It’s time to back up the truck again….

A recession has arrived, is a depression on the way?

Thursday’s GDP report of a 0.3% third quarter decline confirms what everyone already knew, we are in a recession (declining economic activity) and with credit almost impossible to obtain the Fed is desperately trying to prevent a repeat of the Great Depression. Friday (11/07) the monthly jobs number will be released and it should be ugly with a decline of over 200,000 jobs in October and an unemployment rate of 6.3% (on its way to 8.0%). California is on its way to 10.0% and soon every state and local government will be sending delegations to Washington D.C. begging for a handout/bailout similar to the ones given brokerage firms, insurance companies, banks, auto manufacturers and others. How can Washington turn cities and states down when they have funded everyone else (except Lehman, Bear Stearns, Wachovia and WAMU)? What you allow, you encourage and with a new administration it will be hard to resist the cry for help by so many in need. The stock market appears to have stabilized for now and might be close to a trading rally but with liquidity low and rampant bullishness by those still long (and praying) it is not for those that don’t employ stop losses.

2009 will present tremendous opportunities for those in cash but sadly the majority is leveraged with no ability to borrow for new investments. The few that weren’t afraid to win alone are ready for the next adventure while those that don’t mind losing in company at least have their friends to hold their hand with excuses that no one could have forecast this disaster because we only see the future from our own past experiences.