FOMC Preview: Stock Market Pricing in a New QE

Today started the Federal Open Market Committee’s (FOMC) two day meeting on monetary policy. The meeting will conclude tomorrow afternoon with a decision on interest rates (unchanged), which will be followed by a statement of text (look for changes) and after that, the great Chairman himself, Ben Bernanke will give a press conference.

If you have followed my work from my time at Minyanville Media where I wrote the Active Investor, you know that for six months I have been predicting some sort of Quantative Easing to happen this summer.

It looks like that prediction will be correct as it seems some sort of QE will happen this summer.

Goldman Sachs believes that tomorrow the fed will announce some sort of new QE program. The investment bank, sees the possibility of the Fed buying MBS or just extended the Operation Twist.

The thesis is based on a June 6th speech on criteria needed for more QE by Vice Chairwoman Janet Yellen:

“[i]f the Committee were to judge that the recovery is unlikely to proceed at a satisfactory pace (for example, that the forecast entails little or no improvement in the labor market over the next few years), or that the downside risks to the outlook had become sufficiently great, or that inflation appeared to be in danger of declining notably below its 2 percent objective…”

It looks like all three criterions are close to being met, though not quite there yet. If Bernanke wants to stay ahead of the curve, it would make sense to announce some sort of intent to perform QE, at the next meeting (August I presume) if conditions continue to deteriorate.

If that’s the case, what will the new easing program be? .

What I think will happen is the fed may announce a perpetual easing program.  By that, I mean the fed will announce it will purchase treasuries, MBS, etc. at a clip of $50 bln to $75 bln per month. This is known, as a “flow” of purchases and it will allow the fed to react flexibly to quickly changing economic events. It also does away with the idea of QE 3-4-5, etc. As Apple CEO Tim Cook said, iPad 20 doesn’t sound that great. I would almost think of QE, like the fed’s ability to move short-term interest rates, as just another tool in the box.

Trading wise, if that happens, I would buy gold and lots of it. That said, I always like to see what the stock market is doing heading into the Fed and currently it has rallied for four straight days. This tells me that Mr. Market is expecting some sort of QE announcement tomorrow.

While the stock market is saying QE, the fixed income market is pricing in a operation twist expansion/extension. If this is the Fed’s plan, I expect a large sell off in the stock market.

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