As Stocks Enter Bear Market Territory, QE3 Looks Likely

The U.S. stock market has now officially entered bear market territory, with a loss of 20% from its April highs as investors flee risk assets over fear of a sovereign default in the Eurozone and a recession in the U.S. The situation is starting to reach a tipping point as markets continue to gyrate violently and an air of panic similar to that of 2008 sets in. In the near-term, it seems as if market stability is highly unlikely. When the Fed announced "Operation Twist" in September, it was greeted with derision by risk markets, which were clearly hoping for more quantitative easing. Given recent events, it is probably on the way at some point. In testimony in front of Congress's Join Economic Committee today, Fed Chairman Ben Bernanke said that the central bank “will continue to closely monitor economic developments and is prepared to take further action as appropriate to promote a stronger economic recovery in a context of price stability.” This reflects the same language that the Fed has used repeatedly in the wake of this year's deep stock market losses and sluggishly growing economy. He also urged lawmakers to not make draconian cuts to the budget during this time of extreme uncertainty. He said, “A second important objective is to avoid fiscal actions that could impede the ongoing economic recovery. Putting in place a credible plan for reducing future deficits over the longer term does not preclude attending to the implications of fiscal choices for the recovery in the near term.” In recent months, the Federal Reserve has adopted an attitude that suggests they are starting to run out of monetary tools to deal with the crisis. As a result, they have ramped up calls for there to be more done on the fiscal side of the equation. When all else fails, and it will, we will probably yet see another giant QE program. The problem, however, for both the Fed and the Congress, is that the political climate has changed dramatically and more fiscal and monetary stimulus is likely to cause an uproar. It may be the only way for the proverbial can to be kicked down the road, but it would cause extreme political fallout, given the strong and vocal fiscal conservative bloc that now exists in Congress and throughout the citizenry. However, the Fed, which is independent and can essentially take any monetary steps it deems fit may have no choice but to begin printing money again. This is the ultimate quick fix solution, and QE2 has been an abysmal failure, but this is all that is left in Bernanke's playbook. Look for QE3 sometime in the not so distant future, and expect a considerable political and social uproar as a result.