Bernanke is very capable and his resolve gives me comfort, but as former Fed Chairman Alan Greenspan told us when he was running the central bank, there are important variables in monetary policy that the Fed cannot know for sure: Among them are the lags between the Fed’s actions and the response in the economy and the precise sensitivity of the economy’s response to the Fed’s actions.  It is like steering a large transatlantic ship while watching in the rear-view mirror.  By the time you see an iceberg, the ability to reverse or alter the course is very limited. If we observe that the level of both monetary and fiscal intervention in the economy is at historic highs, then we have to understand that applying the just doses of intervention and reducing those doses as the economy gains a "self-sustaining" pace is a very tricky exercise.  Even allowing for the best of intentions and the immaculate professional abilities of the Fed, this will be a very difficult task to pull off.  And what is self-sustaining growth, anyhow?

We also need to understand that the current reflationary policy, which was employed to prevent the country from falling into a deflationary spiral, is actually seeking to create a little inflation.  And it would be unpardonable to see the country fall back into a double-dip recession after all this intervention, should the Fed pull on the reins too soon. 

In fact, the Fed and the Treasury Secretary Timothy F. Geithner have repeatedly led us to believe that they intend to see the recovery ingrained before withdrawing significant amounts of stimuli.  It makes all the sense in the world.  The logical implication is that they would rather see an unpleasant reading or two on the inflation front than see an unpleasant reading on the growth side.  It is a very difficult situation to manage and they are not perfect.

So right now, when inflation expectations are well subdued, it is a good idea to add a position in Treasury Inflation-Protected Securities (TIPS).  The easy way of doing this is by buying the iShares Barclays TIPS Bond Fund (NYSE: TIP).

All of these pending uncertainties that I mentioned are adding to the traditional summer doldrums and we are seeing very low stock trading volumes.  So we are going to take advantage of the situation to get a good valuation on these bonds well before inflation expectations pick up. 

Also, adding bonds to the portfolio has a stabilizing effect.  And the two traditional worries with bonds: A drop in the value of the U.S. Dollar and an increase in inflation are actually hedged, at least in part, with TIPS.  Because inflation is fully hedged as the principal is indexed by the consumer price index (CPI) index.

(By Horacio Marquez)

Recommendation:  iShares Barclays TIPS Bond Fund (NYSE: TIP) at market (**).
(**) - Special Note of Disclosure: Horacio Marquez holds no interest in the iShares Barclays TIPS Bond Fund.