QE3 Is On Its Way, Just Ask The Fed

You don't need to worry whether QE3 is coming, the Federal Reserve essentially just told you it was. In an interview with the

former Fed officials Donald Kohn, Vincent Reinhart and Brian Madigan said they would support the Fed doing more easing if the economy started to experience deflation. It has become abundantly clear that a new round of securities purchases is under heavy discussion at top levels, as the interview was done with Jon Hilsenrath. Hilsenrath is one of the main sources from the Fed to Wall Street, and if the above mentioned former Fed officials are discussing it, you can be sure Ben Bernanke, Bill Dudley, and others are discussing it as well. Donald Kohn, Vincent Reinhart and Brian Madigan said they put a possible economic contraction estimating between 20% and 40% odds. With oil dropping well off the highs, gold and silver surging like nobody's business, and weak economic data, the need for QE3 has certainly increased in recent months. Still, it would not be a cure all, as it has proven in the past two rounds of QE. Madigan, who advises Barclay Capital, said that “Purchases of that order of magnitude [$600 billion] could be helpful at the margin." Ben Bernanke told Congress last month that he would act if the economy continues to weaken, and nothing since then has disproven his point. ISM, PMI, and other economic reports have come in much weaker than expected, and the threat of deflaiton appears very real. Sure, gas prices are sharply higher than they were a year ago, as are most food prices. Fortunately, or unfortunately, from your perspective, the Fed does not look at food and energy when factoring in the official inflation data, as it considers the ups and downs "transitory." Friday will be a huge step for an additional round of QE, as we receive the July Nonfarm payroll report. If it is as bad as June's report was (18,000 jobs), be prepared for the Fed printing press to start up again. How much will the Fed do? This is anybody's guess, but I suspect it will not be as much as the $600 billion we saw last year, but possibly an open ended amount. Perhaps the Fed will state we will purchase $300 billion or so in securities, and then add on as they see fit. This is pure speculation, but it does seem to fit the current line of Fed thinking. “We're flying the plane slower and closer to the ground, so we're less resilient to adverse shocks,” said Reinhart, who stated another recession is near 40% odds. Benzinga has

ad nauseam about

but today's comments make the likelihood that much more likely. When gas is $7 per gallon and a loaf of bread costs $6, thank quantitative easing. It's pretty much all we have left.

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

Traders who believe that QE3 is nowhere close to being 100% certain may consider alternate positions: