QE3 Coming - Now What?

Are the markets already front running a potential announcement of a third round of Quantitative Easing (QE 3)?   Maybe so.  We had expected QE3 at the end of last summer as the economy weakened substantially from the impact of the Japanese earthquake/debt ceiling debate/Eurozone crisis trifecta.  However, with political pressures running high due to the raging battle in Congress raising the debt ceiling there was little support from the public for further intervention.  Furthermore, with inflation, as measured by CPI, already outside of the Fed's comfort zone, the Fed opted to institute "Operation Twist" (O.T.) instead. 

With the Euro-Crisis on the broiler, another debt ceiling debate approaching, the U.S. economy struggling along as Europe slips into a recession and corporate earnings being revised down there are plenty of reasons for stocks to decline in price.  Yet, they have continued to inch up.  With short interest on stocks having plunged in recent weeks it certainly sounds like the markets are betting on something happening and soon.

Let's remember that the goal of both the QE programs and Operation Twist was to suppress interest rates on the longer end of the yield curve in a bet, which has failed to this point, to revive housing.  Those programs did, however, drive a speculative frenzy as money flooded into the financial markets.  As you can see by the chart above the actual implementation of QE1 and QE2 actually kept mortgage rates elevated as money flowed from bonds, suppressing prices and ...