Get Ready For QE3?

Stocks have been rallying sharply, and bonds have been selling off in one of the most powerful rallies in some time, with the Dow Jones Industrial Average gaining more than 1,000 points in seven trading days. It has been hard to justify the reason for the move upwards, as nothing has really changed from two weeks ago. Now we may have a reason why. The Federal Reserve just released their

in which the Federal Reserve decided on the Operation Twist program it is currently enacting. However, the minutes also revealed that the Federal Reserve is leaving open the option of a third round of quantitative easing, should the economy need it. The Fed weighed three options at the meeting: "a reinvestment maturity extension program, a SOMA portfolio maturity extension program, and a large-scale asset purchase program." This paragraph from the minutes appears to be the most supportive to further QE: "Meeting participants expressed a range of views on the potential efficacy of policy tools tied to the size and composition of the Federal Reserve's balance sheet. Many judged that these policies could provide additional monetary policy accommodation by lowering longer-term interest rates and easing financial conditions at a time when further reductions in the federal funds rate are infeasible. However, a number saw the potential effects on real economic activity as limited or only transitory, particularly in the current environment of balance sheet deleveraging, credit constraints, and household and business uncertainty about the economic outlook. Participants noted that a SOMA maturity extension program would not expand the Federal Reserve's balance sheet or the level of reserve balances, and that the scale of such a program was necessarily limited by the size of the Federal Reserve's holdings of shorter-term securities so that it could not be repeated to provide further stimulus.

On the flip side of things, some on the FOMC, including Dallas Federal Reserve President Richard Fisher, Charles Plosser, Narayana Kocherlakota said that doing additional QE would do more harm than good. In the minutes, it read, "Some judged that large-scale asset purchases and the resulting expansion of the Federal Reserve's balance sheet would be more likely to raise inflation and inflation expectations than to stimulate economic activity and argued that such tools should be reserved for circumstances in which the risk of deflation was elevated." The fact that equities have rallied for over a week now without little explanation may now have their reason. Including Chairman Ben Bernanke who is a notorious dove, the majority of the FOMC as it is currently positioned, is dovish. NY Federal Reserve President Bill Dudley, Chicago Fed President Charles Evans, FOMC Vice Chair of the Board of Governors Janet Yellen are all known to be extremely dovish, with Evans perhaps being more dovish than Bernanke. Earlier last month, Evans said we need more easing, and may have to think about

out of the current debt situation we are in. So far, Bernanke has been against inflating our way out of the economic situation, but that is not to say he is not dovish. He is extremely dovish, and unconventional, and has shown the willingness to be aggressive to help the American economy. Atlanta Federal Reserve President Dennis Lockhart has also made

regarding the potential for QE3, as has Bernanke in several instances. Just

Bernanke spoke in front of the Join Economic Committee, and said 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.” The minutes today prove that QE3 is definitely being discussed. Recent economic data has been better than expected, with September PMI and ISM coming in above estimates. Still, the economy is not growing at gangbusters, and the Fed will continue to stand ready, willing, and able to do whatever it can to maximize employment (aka get the S&P 500 to 1,500). What do you think? Is QE3 coming?

Traders who believe that QE3 is coming might want to consider the following trades:

Traders who believe that QE3 does not come may consider alternate positions: