Fed Blows It! Wall Street and Dollar Pounded!

By: Money_and_Markets

Mike Larson writes: Boy, did Federal Reserve Chairman Ben Bernanke blow it this week!

Investors were looking for a strong Fed statement because they believed it would support the dollar and snuff out the recent surge in commodities prices.

But instead of reassuring Wall Street and giving investors an excuse to drive stocks through the roof, Bernanke blinked. Investors expressed their disapproval by responding with a strong statement of their own.

The Dow's 358 point collapse yesterday can be directly traced back to ...

The Fed is TALKING tough about inflation, but making it clear it isn't going to DO anything about it.

Officials talked quite a bit about elevated inflation in their post-meeting statement. They said:

"The Committee expects inflation to moderate later this year and next year. However, in light of the continued increases in the prices of energy and some other commodities and the elevated state of some indicators of inflation expectations, uncertainty about the inflation outlook remains high."

But they didn't go the extra step of shifting to a "tightening bias." In short, the Fed didn't imply that a rate hike was imminent.

After upping the ante all month about the Fed's willingness to fight inflation, Ben Bernanke folded when the market called his bluff on interest rates this week.

I can understand why. Policymakers are afraid that raising interest rates will exacerbate the housing downturn and the economic slump. Plus, it's an election year.

What they don't seem to understand is the old adage, "He who hesitates is lost."

The U.S. Fed is standing pat while central banks in other countries are raising their rates, making the dollar a less attractive destination for international funds. Take a look:

• India raised rates by a half-point this week.
• Norway raised rates by a quarter-point.
• Brazil raised rates by half a percentage point to 12.25% earlier this month.
• And the European Central Bank has strongly suggested it will do so soon.

Even the Bank of England, whose country is also getting hammered by credit losses and a housing slump, has gone nowhere near as far as the Fed. It has lowered rates just 75 basis points since last fall — versus 325 basis points here in the U.S.

There's no getting around it ...

The Fed's refusal to raise rates is accommodating the increase in commodities prices and killing the U.S. dollar.

Fed Chairman Ben Bernanke might as well have come out this week and yelled "Sell the dollar!"

He might as well have said, "Hey you commodities traders, listen up. I'm not going to take away the free money. Have at it!"

Lo and behold, after the Fed news came out ...

• The dollar index has dropped by more than 100 basis points. At 72.49, it's within a few ticks of its 70.69 low. The euro is once again closing in on its late April high of 1.6018. The Australian dollar is this close to blowing off to a new high. And the Brazilian real is heading steadily higher, trading at its highest level against the greenback since January 1999.
  
• Gold has started getting frisky again. It jumped more than $30 yesterday, and looks ready to break out to the upside. Platinum looks strong. And silver appears to be coiling up for a major move.
  
• What about crude oil? It dropped just below $132 a barrel before the Fed news hit. After it did, crude started rallying back. It then added another $5.09 on Thursday to close at $139.64, an all-time high.

My colleagues Sean and Larry have given you plenty of ways to make money from the rally in commodities. And Jack Crooks is your go-to guy for currencies. So I'm not going to focus on that part of the market today.

Instead, I'm going to stick to my knitting — U.S. stocks, interest rates, real estate, and the financial sector. I have to tell you, what the Fed did — or failed to do, really — was like the kiss of death there.

It's "Look out below" time for stocks!

Bank of America's stock has been battered on Wall Street this week, hitting another 52-week low yesterday.

The financial and real estate sectors were all poised to rally on the assumption the Fed would put a knife through the heart of commodities. It didn't. That caused most financial stocks to give up their pre-Fed rally on Wednesday, and then sell off even harder on Thursday.

But that's not even the half of it. You want to hear something scary? The KBW Bank Index, or BKX, is a benchmark index that tracks all the biggest banks in the U.S. — Bank of America, Citigroup, JPMorgan Chase and so on. It's trading right around the 60 level.

The last time it got that low was in the second half of 2002. In other words ...

The biggest U.S. financial stocks have given back EVERY CENT of their post-bear market rally.

As for the Dow Jones Industrial Average, it's hanging on by its fingernails in the 11,600-11,800 range. This area corresponds to the "double bottoms" made in late January and mid-March. If the Dow goes over Niagara Falls like the financials already have, unprepared U.S. investors are in for a world of trouble.

So make sure you own some inverse funds and ETFs for protection. Consider the hedging strategies Martin has laid out here in Money and Markets.

Looking for even more specific instructions? Then make sure you're signed up in time to get this month's Safe Money Report , set to go live next week. We already have several inverse positions that are RISING in value as key sectors fall, and we're looking to add even more.

Our strategy is simple: The only good defense against a Fed that refuses to do its job is a strong offense.

Until next time,

Mike

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