Profit From A Fed That Clearly Has Decisiveness Issues

Summary

• Yellen's testimony on Wednesday was a total reversal from hawkish comments made by Fed presidents last week.
• Another round of QE seems eventually inevitable at this point.
• Move some capital to commodities and out of U.S. equities.

By Thom Lachenmann with Scott Tzu

If there's one thing that Janet Yellen's testimony today proved, it is that the Federal Reserve doesn't seem to have any type of consistent clue whatsoever on what it wants its future monetary policy to look like. The market was just starting to pare back slightly over the last week or two as a result of some hawkish comments out of individual Fed presidents a couple weeks ago indicating that the Fed may start to tighten its balance sheet and continue to raise rates in a clinical fashion despite economic data showing that everything wasn't exactly going according to plan.

In true FOMC fashion, this morning's testimony from Janet Yellen was essentially a complete and total reversal from some of the comments out last week. Yellen offered about the largest dovish softball she could possibly lob out in front of Congress with regard to future monetary policy. During her testimony, she made it clear that while the Federal Reserve is looking to tighten its balance sheet, using its balance sheet for more monetary stimulus going forward wasn't out of the question. In fact, the tone with which she made this comment made it seem as though more economic stimulus is actually the likely solution going forward from the Fed's standpoint.

The second bombshell that Yellen dropped today was the fact that she doesn't expect the neutral rate to be much higher than the current interest rates. While she claimed several times over that the Fed would likely continue to inch rates higher over a gradual time span, her comments are anything but hawkish and they gave us the indication that the current rate hike pattern may slow down substantially and ultimately culminate in its entirety somewhere between 1.5% and 2.5% (our estimates), depending on how bad the next couple of years get.

Not only is it a ridiculous policy in and of itself, it is a far cry from any type of hawkishness that had led many to believe over the last few weeks that economic stimulus could be withdrawn from the market successfully and leave both equity markets and the economy in a position of strength. We believe this simply just isn't possible. The mechanics of the economy are such that when the Fed begins to offer for sale what's on its balance sheet, while at the same time hiking rates, it is no doubt going to bring the economy to a screeching halt and cause equity (and Treasury and MBS) markets to do the same.

At this point, we would be surprised to see the Fed unload anything that's on its balance sheet, and equally, we would be just as surprised to see the federal funds rate move anywhere much higher than 2% over the coming two years. The problem is that the economy is starting to slow down on its own, and while it was "booming" over the last seven or eight years, the Fed stood idly by instead of clinically adjusting monetary policy to help quell the boom and make somewhat of a return to normalcy. Now, we are at the catastrophic scenario where the market has overextended itself in a significant manner and the Fed has very few policy tools to help itself stimulate the market if it needs to, short of inventing a $1,000 bill and printing that, instead of $100's.

At a time like this, it becomes difficult to try to figure out how to invest appropriately. It falsely becomes somewhat of an obvious conclusion to pile back into US equities, as the market moves higher on comments like the one Yellen has made today. But at some point, one is also going to have to look at what the effects of continued monetary stimulus will be on the economic environment going forward. While equity markets and asset prices may continue to see some appreciation as the Fed continues to target (and probably eventually overshoot) 2% inflation, the dollar will likely continue to fall in value similar to the way it did today. This will not only decrease purchasing power for more expensive assets but will also lower quality of life and standard of living for those whose earnings don't move up commensurate with inflation.

As usual, "savers" of fiat currency will get the short end of the stick, as money that has been socked away will continue to depreciate in value at the rate of inflation. The prospect of continued monetary stimulus introduces the potential for the dollar to really suffer some meaningful depreciation over the course of the next 12 to 18 months. In situations like those, we like to turn to commodities. While gold, silver, platinum and other metals are some of our favorite investments as a hedge against a depreciating dollar and potential aggressive inflation, allocating a portion of US equity investments into emerging stock markets (like Australia, for instance) and well established global currencies (like the euro and Swiss franc) may also prove to be prudent strategies over the course of the next seven- or eight-year economic cycle.

The Fed's indecisiveness on what it wants to do and what it is capable of doing is not only alarming, but it is also telling for the way things will go over the next couple of years. With no clear cut path on what type of monetary policy we want to use going forward, we think now is probably not a bad time to take some gains from equities and real estate over the last few years and move them into hedges against the system like commodities, precious metals international stocks and possibly even a small allocation in digital currency.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

We own silver and gold, Bitcoin and Ethereum