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QE2 rumored to disappoint, but that's good news



Today's WSJ article, "Fed Gears Up for Stimulus", appears to be a Fed leak that discloses a QE2 program "worth a few hundred billion dollars over several months," far less than the Wall Street pundits were predicting as recently as yesterday.

Not surprisingly, the stock market was immediately disappointed, though it later recovered much of its losses on the day. The Treasury market took it on the chin—also not surprisingly—though it would appear that suspicions of a disappointing QE2 must have been at work for the past two weeks, since 10-yr yields bottomed Oct. 11th at 2.39% and ended today at 2.71%. Gold peaked at $1387 on Oct. 14th, and ended today at $1328. Most encouraging, I think, was the fact that the dollar bottomed Oct. 15th and closed today up 2.7% from that low. All in all, these moves were predictable, given a disappointing QE2 announcement. Despite the 30 bps rise in 10-yr yields in the past few weeks, stocks are roughly unchanged.

Maybe this was a trial balloon from the Fed. If so, the takeaway should be this: there is NO NEED for QE2 at all. Faced with the prospect that QE2 would be quite small and dribbled out over months, the stock market barely budged, while Treasuries and gold suffered a drubbing and the dollar rose nicely. This means the market viewed QE2 as only marginally—if at all—important to the economy, but very important to the dollar and Treasury bonds. Another injection of money from the Fed was unimportant insofar as the economy was concerned, but the prospect of fewer dollars being jammed into the system was a great relief for holders of dollars and it gave pause to those running to gold for protection.

I'm quite pleased with today's action, since to me it is a sign of a market that is operating rationally. The message from the market to the Fed should be clear: we don't need your stinkin' QE2—it would only muddy the waters.

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