The “Shock and Awe” of the Federal Reserve

Nicholas Vardy

Nicholas Vardy has a unique background that has proven his knack for making money in different markets around the world.

The move triggered a plunge in both bond yields and the U.S. dollar, hitting two of your positions in the Global Bull Market Alert portfolio. The Rydex Inverse Gov Long Bond Strategy Inv (RYJUX) plunged nearly 8% from its near record highs. And the Market Vectors Double Short Euro ETN (DRR) fell sharply as the U.S. dollar fell 3.2% against the euro.

The jury is still out on the Fed’s actions. One way to view it is as part of the Fed’s commitment to, as Goldman Sachs said, “throw the kitchen sink” at the challenge of reviving the U.S. economy. Another view could interpret “quantitative easing” as a sign of desperation. Only time will tell. The most important thing from an investment standpoint is that you stick to your stops. Competing opinions are fine. But preserving your capital and making money in challenging markets is even better.

There is one technical point about the Fed’s actions that should benefit your position in RYJUX. After Treasuries collapsed following the initial announcement, the Federal Reserve Bank of New York announced that it will “concentrate purchases in the two- to 10-year sector of the nominal Treasury curve. This reflects the Fed’s objective to “improve conditions in private credit markets” — not to help the government finance its mounting deficits.

That means RYUJX, which focuses on 30-year Treasuries, will be less affected by the Fed’s actions than its shorter duration counterparts. It didn’t take long for the market to catch on. Traders immediately dumped 30-year bonds, sending the yield back to 3.70%. By contrast, yields for the five-, seven- and 10-year notes did not experience a similar rise. The 10-year note was down 51 basis points to 2.49%, near its low for the day late in New York trading, while the seven-year note was down 54 basis points at 2.08%.

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The bottom line? The fundamental reason for betting against U.S Treasuries remains intact. The Fed has just increased the size of its balance sheet by another $1,150 billion to $3,000 billion. And that’s even before the roll-out of a $1,000 billion scheme to finance credit markets. Once this scheme is fully implemented, its balance sheet could approach $4,000 billion — nearly a third the size of the U.S. economy. It’s hard to imagine that this money creation won’t lead to inflation. And that is bullish for RYJUX.

Turning to the currency markets, the U.S dollar fell 3.2% against the euro. It marked the dollar’s biggest single-day drop against the euro in several years. As a result, your position in the Market Vectors Double Short Euro ETN (DRR) was hit hard. This has not fundamentally changed the negative outlook for the euro. Europe’s PIGS (Portugal, Ireland, Greece, and Spain) and certain countries in Central and Eastern Europe are still facing a major economic contraction. European policymakers are still hamstrung by the lack of institutional framework for economic policy. And the euro remains the most overvalued major currency in the world.

With economic news coming out of the United Kingdom continuing to be grim, the outlook for your bet against the British pound sterling by shorting the CurrencyShares British Pound Sterling Tr (FXB) looks positive. And not unsurprisingly, your bet on gold through the SPDR Gold Shares (GLD) ETF soared 3.4% in yesterday’s trading.

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