The Fed's 'Twist' And The U.S. Economic Outlook

 |  Includes: DIA, QQQ, SPY
by: Calder H. Lamb

The Federal Reserve has announced that it will continue "Operation Twist" and will not engage in additional QE measures. The Federal Reserve issued a news release today, June 20th, that stated, in part:

The Committee intends to purchase Treasury securities with remaining maturities of six years to 30 years at the current pace and to sell or redeem an equal amount of Treasury securities with remaining maturities of approximately three years or less.

The Fed believes that by purchasing long-term Treasuries and selling shorter-term Treasuries it can exert downward pressure on future interest rates. The Fed believes the downward pressure will make general financial conditions more accommodative. At the end of the press release, the Fed reiterated a message it has repeated again and again: "The Committee is prepared to take further action as appropriate to promote a stronger economic recovery and sustained improvement in labor market conditions in context of price stability."

So what does this mean for the markets?

The markets reacted to the press release with an immediate drop in value, followed by a roller coaster of volatility. Much of that initial decline can be attributed to speculators seeking to gain from a QE event.

When initially reading the dry press release, one may miss the larger implications about the future of the U.S. economy. The future of the economy looks dim. The bleak outlook given by the Fed agrees with recent economic surveys and data. For instance, Reuter's survey of CEOs, released today, signaled a significant decline in economic activity. The survey's GDP estimate fell 0.2 from 2.3 to 2.1, citing concerns with Europe and the deadlock in Washington as the major concerns. The Index of U.S. Leading Indicators, which usually has a three to four month look-ahead period, has also fallen from 1.68 to 1.55 over the last three months. Furthermore, the personal savings rate is down from 4.8% to 3.4% in just a year's time. The decline of the personal savings rate implies that consumers' wallets are already heavily strained and there is not much wiggle room in the U.S. economy.

The Fed press release and these economic indicators all suggest that the U.S. economy is due for a downturn. A long put position on the SPY, QQQ, DIA, or any major U.S. index could potentially hedge your investments from downside risk.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.