Thoughts on Fed Moves

Ok, I'm not sure whether Bernanke makes his reappointment vote this week but obviously the market won't like it much if he doesn't get confirmed by this weekend.

More important to the economy is whether the Fed follows through on their indications to withdraw from the MBS market at the end of March. I know I have posted on this topic before but I feel it is going to be an important driver of the markets. Apparently mortgage rates haven't backed up that much yet, so is this the markets telling us that the Fed won't do it or are the markets going to discount this between now and then? The reason I keep harping on this is that the government now plays such a large role in the supposed free markets. You can't just look at different sectors or asset classes without knowing what the Fed and Gov't might do! The Chinese authorities directing their banks to curb lending and thus roiling markets is a recent example.

As I have stated before, if the Fed backs down and continues MBS purchases, this is very bearish for the dollar. Typically when there have been dollar shocks, gold has had a disproportionate move upwards.

Now what I haven't discussed before is, how the banks might fare if the Fed does manage to stop their intervention in the debt market. The long rate is set to go up to what the market deems to be the free rate of interest, thus steepening the yield curve. One thing I do know is that inflation is tame and the Fed is locked into low short term interest rates. Steep yield curves are great for banks in general. Unless the financials blow themselves up with subprime or Alt-A mortgages, any prudently managed bank should thrive under this scenario of tame inflation and a steep yield curve.

This is where I think Cdn financials and XFN still fit in. The Cdn banks have been better managed than their US counterparts and as far as we can tell, they don't have any off balance sheet 'assets' that might still haunt them.

What I'm proposing is to sell QQQQ instead of XFN, and add gold either now or when the Fed looks like they won't follow through.

There's always the question of time lags of course. The banks don't benefit immediately from rate rises and their earnings may not go up for a few quarters. Why couldn't markets only be efficient when we want them to be!