An ETF to Win with Operation Twist

12/20/2012 7:45 am EST


Genia Turanova

Editor, Leeb Income Performance

The Federal Reserve is continuing its easy money policy to boost the still-weakened financial and real estate sectors, but this policy leads to an unusual opportunity, notes Genia Turanova of Leeb Income Performance.

Two market-moving (or potentially market-moving) events have been in focus over the past week. While the fiscal cliff remains front and center of the market's waiting game, the Federal Reserve's policy meeting, as always, was the event that had both a longer-term and an immediate impact for both traders and investors.

As its Operation Twist program expires at the end of the month, it was widely expected that the Fed would expand its bond-buying program. And the Fed did just that: the FOMC voted to supplement its $40 billion-a-month in mortgage-bonds purchases with the monthly buying of $45 billion in US Treasuries.

In response, Treasury bonds fell. Mortgage rates continued to decline, and are again near record low levels. We also learned something new about the Fed's policies: the FOMC has incorporated employment and inflation targets in its policies.

What does this mean? Theoretically, once unemployment falls to the target level of 6.5%, the central bank will consider raising short-term interest rates again. When can we expect that to happen? Not until 2015, according to current forecasts from the majority of Federal Reserve officials. Therefore, at least until then we should expect to continue to have the near-zero rate policies in place.

The Fed used the "at least as long" phraseology here-so it's even possible that we will see the continuation of current policies for a while longer, even as the unemployment numbers improve. Another deciding factor will be expectations about the rate of inflation "between one and two years ahead." Until inflation is projected to be no more than 2.5%, the current easing policies will remain in place.

What about the rate of growth in the economy? The Federal Open Market Committee's forecast is that next year GDP will expand 2.3% to 3%, compared with the 2.5% to 3% increase forecast in September. In 2014, they expect it to grow at a 3% to 3.5% rate.

Stocks are under pressure because the record easing means, in the long run, higher inflation. By replacing its expiring Operation Twist with new Treasury purchases, the Fed is moving to expand its balance sheet. As noted by more than one commentator, the unlimited moneyprinting cannot fail to result in higher inflationary pressures as one of its side effects.

How to play the Fed's new policies? One good income-oriented solution remains the Australian dollar, via the CurrencyShares Australian Dollar ETF (FXA), which yields 2.3% and remains a strong recommendation at its current level.

The contrast is clear: the US dollar will naturally be debased by the Fed's continuing expansionary monetary policy. But the Australian dollar, on the other hand, traded near its highest level in almost three months yesterday, before giving up some of the gains in today's trading.

The Australian dollar is also being helped by better reports from China, as fears of a hard landing there have proved to be exaggerated. As China is Australia's largest trading partner, any improvement in economic data coming from that emerging economy behemoth will inevitably help the Australian economy and its currency.

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