Fed Moderating QE2 Expectations

Jon Hilsenrath at the Wall Street Journal has been the Fed’s leaker of trial balloon statements. This morning wrote the following –

“The Federal Reserve is close to embarking on another round of monetary stimulus next week, against the backdrop of a weak economy and low inflation—and despite doubts about the wisdom and efficacy of the policy among economists and some of the Fed's own decision makers.

The central bank is likely to unveil a program of U.S. Treasury bond purchases worth a few hundred billion dollars over several months, a measured approach in contrast to purchases of nearly $2 trillion it unveiled during the financial crisis. The announcement is expected to be made at the conclusion of a two-day meeting of its policy-making committee next Wednesday.”

http://online.wsj.com/article/SB10001424052702303891804575576533845166848.html?mod=googlenews_wsj

That can’t be good. This entire rally has been on the back of an imploding Dollar, which has crashed because investors don’t want to hold the currency with the 2nd lowest Interest Rate on the planet and a Central Bank intent on printing enough money to drive the entire yield curve to zero if it is required.

If you read what Brian Sack of the NY Fed said about how the Fed buying bonds has had the benefit of propping up asset prices, then you know that the whole Quantitative Easing game has nothing to do with getting credit to the consumer and everything to do with making their mutual fund statements and housing price values look better.

Any way you slice it, there seems to be significant risk for Interest Rates right now. I say this because Interest Rates rallied sharply during the first part of QE1, as expectations for economic expansion drove people out of Bonds (see yesterday’s post). They have now rallied on expectations that the Fed will buy $100 billion of them a month until Inflation gets to 3-4% per year.

So if the Fed announces massive QE2, then expectations of growth impact Interest Rates and if QE2 is small then the lack of expected Fed demand for buying Treasuries hits bond prices, driving rates higher. Rising rates help currencies appreciate and a rising Dollar is not good for markets levered up on the Dollar Carry Trade.

http://www.ny.frb.org/newsevents/speeches/2010/sac101004.html

Gold, Silver, The Euro, The Brazilian Real and US Treasuries have all been telegraphing a potential pause or reversal in the vertical move for risky assets. Maybe we simply see extended prices revert back to their 50-day averages or maybe we get the hedge fund crowd to all run to the other side of the boat at the same time and take us back down as quickly as we just shot up.

The Fed has been horrible at anticipating and unwinding the bubbles they have caused. It is a matter of when and not if they mess up the unwinding of the Treasury/Commodity bubble they are now blowing.

I will keep a close watch on hourly support levels to see when real weakness finally starts to show up.

You can see that the indexes are right on top of significant support zones in the 240-minute charts –
S&P 500 (ES Z0 240-min), Dow (YM Z0 240-min) and NASDAQ 100 (NQ Z0 240-min)