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News Analysis: Fed Seems to Have Downgraded Last Month's Uncertainty

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The Federal Reserve announced Tuesday, August 10, that it would roll over its maturing mortgage bonds into long-term Treasury purchases. The move is an admission by the Fed that the biggest risk to the U.S. economy is a deflationary spiral; moreover, the government debt purchases are a return to Fed Chairman Ben Bernanke’s stated willingness to throw money from helicopters if necessary.

It is worth recalling how Bernanke very gingerly set up this rather drastic move, in congressional testimony on July 21. At that time, he called the outlook for the economy “unusually uncertain” and expressed a willingness to take further policy action if needed.

Apparently, plunging home sales since expiration of the home-buyer rebate, accelerating job losses in the latest unemployment report, the enormous spike in our trade deficit with China (and the People’s Bank of China pushing down the yuan, signaling an even less favorable climate for U.S. exports going forward) — all this and more data indicating U.S. economic weakness have confirmed Bernanke’s worst fears.

I would venture to guess that Bernanke thought it looked this bad on July 21, and gently (as he should) hinted as to what might happen down the road. Well, that part of the road was traversed not even three weeks later, with Bernanke’s August 10 Treasury purchases announcement.

Financial advisors may conclude that now is a good time (if they have not already done so) to batten down the hatches of their clients’ portfolios. Long-term Treasuries should do well in the short-term at least; equities may have further to fall. If we are genuinely heading into (or already into) the feared double dip, we could again see declines in nearly all asset classes.

One clever advisor I know (who makes no prediction about the economy or market) is loading up on DXCTX, a commodity trends index that benefits from volatility — up moves and down moves, (while declining in times of low volatility). The hefty 1.93% expense ratio of this Direxion fund may be the price investors pay today for the fear clients experience in the turbulent markets ahead.