The Fed Takes a Victory Lap - But What Happens Next?

Last fall, after the Fed announced its second round of quantitative easing (a.k.a. QE2), Ben Bernanke wrote an editorial in the Washington Post.

Here was an excerpt from that piece, which was published on November 4, 2011 (I have added emphasis):

Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.

http://www.washingtonpost.com/wp-dyn/content/article/2010/11/03/AR2010110307372.html

If you ever needed confirmation that the Fed wanted you to buy stocks and bonds, this was it.

And here's what Random Glenings wrote in early November:

Wednesday, November 3, 2010

The Fed Wants You to Buy Stocks and Bonds

..I don't know if there is a precedent for this, but Fed Chairman Bernanke has an editorial in this morning's Washington Post...


In other words, the Fed wants bond and stock prices to move higher, and is willing to throw a cool $900 billion ($600 billion + reinvestment of interest from existing holdings) into the capital markets between now and the end of June 2011 to help this happen.

Do you really want to bet against the Fed?...

..I'm not sure about the longer run impact of QE2, but for now I think you need to be fully invested in the markets.

Well, the Fed "won". We just finished the best first quarter for the S&P 500 since 1988 (+5.9%). For the last six months, the S&P is +17.3%. And Treasury 10 year bond yields have defied expectations, and at 3.45% its yield is nearly 40 basis points lower than a year ago.

Question is: What happens next?

It is not inconceivable to me that QE3 is possible. Although Corporate America seems in pretty good shape, housing is depressed (to put it mildly), real income growth remains stagnant, and unemployment is still too high.

However, the political reality is that there is no appetite in Washington for more government
intervention in the markets. So we will have to see whether the recent market gains can hold without market support.

There is, however, considerable skepticism among the market pundits that the Fed can go quietly into the woodwork. Bill Gross from Pimco, for example, has been quite vocal in his belief that Treasury yields will need to rise considerably from current levels to induce private investors to purchase bonds.

Should be an interesting second quarter.