The Power Behind A Couple Of Words

Is QE III a reality, and if so, how will it impact the bond market?

When the Federal Open Market Committee releases minutes from its meetings, it is usually a nonevent. That was not the case on April 2 with the release of the March 13 minutes.

In late March, the markets interpreted a speech of Bernanke’s as confirmation the Fed will keep rates low until late 2014 and a third round of quantitative easing is likely. The markets surged on this news. According to the FOMC’s January minutes, a few members thought additional easing measures might be needed depending on economic conditions; its March minutes, however, indicate a couple of members feel that way. The minutes caused the markets to plunge. One-half of that couple of members is Bernanke, whose share of the pie is larger than the others, but traders still reacted strongly to the possible move away from more free money.

Despite the fact his statement this month was little changed from January, the markets took minor language changes in the minutes such as the use of couple rather than few as a sign the Fed is moving away from further easing measures.

How Does QE III Speculation Impact Stocks And Bonds?

The two biggest moves in both stocks and bonds in 2012 have come on speculation about QE III. Bernanke’s speech earlier this month caused stock and bond prices to surge. The release of March’s minutes caused both to plunge.

The markets reactions seemed extreme relative to the news. The bond market’s reaction is understandable. The Fed has been the biggest buyer of debt, and a possible withdrawal is unsettling. The stock market’s reaction is less rational. The market should be happy to see the Fed gain confidence in the economic outlook. Low rates for an eternity would mean the economy will continue to underperform.

Despite Wall Street’s bravado about a growing economy and better earnings, its reactions in the market tells us it is still hooked on free money and fears life without it. After more than three years of Fed largesse, this is understandable so Bernanke wastes no opportunity to reassure the markets help is a phone call away.

But it’s bad policy to baby-sit markets, and it’s good to see voices other than Wall Street’s are being heard. However, Bernanke’s voice is really the one that matters. The Fed might decide to inject more QE money, but that decision should be based on economic and financial conditions not on the dependency needs of Wall Street.

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April 12, 2012

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