Wednesday, January 26, 2011

Pick your Death: Stocks or the Dollar

That's the reality here folks.  The Fed is now officially painted into a corner when QE2 ends in June.

The March to June time frame will be the turning point for the markets.  My guess is we drift higher for the next few months as the Fed keeps pumping like a two bit whore on 42nd st.

The FOMC statement was totally predictable.  Stay the course and extend and pretend!!!  Like I said yesterday, Ben will continue doing this until the markets force him to stop.

The bond market didn't the FOMC statement because they realize the stupidity of QE.  Here is the 10 year:

Quick Take:

There really isn't a lot to say about the tape right now.  The bulls are stampeding across Wall St because Ben continues pumping the market with dollars.

My guess is beginning in March this rally is going to lose some serious steam as the big players start hedging their bullish bets as QE2 inches closer to ending. 

The million dollar question is does the Fed have the balls to cut off the program?  I doubt it if they think they can get away with a QE3.  The problem  they have is I don't think the bond and currency markets will let him.

Just look at the hissy fit the bond market threw today when the Fed simply announced that they planned on maintaining QE2.

The Bottom Line

Somethings got to give when June comes around folks.  Here are my two scenarios:

Scenario 1:  The Fed Pulls the QE3 Lever

The way I see it, if the Fed tries to continue printing I think you could see chaos in the bond market.  The dollar and treasuries would nosedive on the announcement. 

I see a scenario here where the markets could possibly act as a hedge against a crashing dollar and move higher as the resource and mining stocks surge as Wall St looks to protect themselves from a collapsing currency and soaring inflation. 

The Fed may roll the dice and try and pull off QE3.  They know if they don't then the whole house of cards comes tumbling down without further printing.   There isn't any demand for risky paper like MBS or the long end of the treasury curve without the Fed backing it.

I mean think about it:  Who on earth would buy a 30 year bond if QE3 is announced and the dollar starts to crash?  You would have to be a total moron to even touch the stuff.

I also see a scenario where QE3 could tank the markets.  Stocks could collapse if the bond market goes apeshit and pulls a "Greece" in defiance to the Fed's printing.  Another risk for equities would be a falling dollar which would force energy prices to soar.  This would tank the consumer and the higher interest rates would destroy the housing market.  If this is how it plays out it's Game Over.

Scenario 2:  The Fed "Walks Away"

This one is easy.  Deflation takes over and everything collapses.  Investors would run for the hills from both treasuries and stocks because the Fed would no longer have their back.  Demand for treasuries would tank on the simple fact that the Fed would no longer be purchasing them.

Interest rates would then rise, commodities would get crushed as demand collapses, and the dollar would likely strengthen because the Fed would no longer be destroying it via printing.

The banks and housing would both be toast as housing prices crash as a result of soaring interest rates and higher unemployment.  Unemployment would soar because budgets and entitlements would have to be slashed because the money simply wouldn't be there to continue paying them.

My Preference?

Both would be painful but scenario 2 is a much less painful route to take IMO.  The soaring inflation seen in scenario 1 would eventually lead to scenario 2 anyway because no one could afford to live.  Prices would eventually crash because there would be no demand due to lack of affordability.

I wish I saw a way out of this folks.  Unfortunately, I don't see how we don't go down one of the two paths described above.  My guess is the Fed chooses scenario #1 out of desperation.  They know there are no markets without them. 

Just look at the credit markets if you don't believe me.  It's virtually non existent unless the paper is backed by the government.

Enjoy the breather over the winter as Ben throws money out of helicopters.  Things aren't going to be pretty in the latter half of the year.

1 comment:

getyourselfconnected said...

AMAZN missed adding to a list of high profile misses. Not that it matters.