QE2 Is Now 'Transitory': How Will That Affect Markets? (Guest Post)

By Ilene

Here are some highlights from the latest Wall Street Examiner's Professional Edition. Lee Adler's perspective on the stock market is extremely insightful as he tracks factors we don't often consider well enough in anticipating how the markets are going to move. Unfortunately, the stock market is largely at the mercy of the money flows between the Fed, the Treasury, Primary Dealers, foreign central banks, the banking system, and the markets. Lee closely follows these money flows and explains how they are likely to affect the markets. 

"Virtually all key liquidity indicators are negative as the markets hurtle toward the end of QE in a little over 3 weeks. Large domestic bank trading accounts, bank purchases of Treasuries and Agencies, and foreign central bank purchases of Treasuries and Agencies are all bearish. The indicator showing net cash flowing from money funds into the banking system is on the cusp of turning bearish.

These patterns continue to suggest that the market will be vulnerable to an even bigger decline than the one already under way once quantitative easing ends. The fact that there's been some front running of the end of QE, and the fact that most people “know” that ending QE will be bearish, are not reasons to take a contrary stance and believe that the market won't decline.

Unless the money flows we are seeing now reverse, and I see no reason why they should, then the stock market should head lower. Liquidation of stocks may boost Treasuries for a while, but I expect that effect to be, in the immortal words of our dear leader, Fearless Ben, “transitory.”

Once the disaster I expect begins to unfold, Ben will start meddling in the market again. Primary Dealers have been buying MBS hand over fist, so my guess would be that they're looking to unload it on the Fed in the not too distant future. They either know something or intend to strap this stuff to their belts and threaten to blow themselves up if the Fed doesn't buy it from them.

Wall Street keeps telling us that there will be plenty of buyers for Treasuries once the Fed stops POMO. All the evidence that I now see points in exactly the opposite direction. Not only are the PDs treating Treasury paper like last week's garbage, banks in general are also dumping the stuff. Only foreign central banks have been good public servants picking up tons of the stuff in recent weeks, but even that appears to have stopped. If they go on strike, it will be a catastrophe for the market.

After [the end of the QE2 buying program], [Fed] will go cold turkey....While the market's reaction may not be immediate, I expect it to be profound, with losses primarily hitting stocks as the government's manipulators and dealer henchmen attempt to use liquidation of equities to support the Treasury market. I'm not sure that will work for long. Treasuries should begin to weaken before too long. We'll have to watch the technicals closely."

On the Primary Dealers, Lee had this to say, "....the idea that the biggest of them go day in and day out without trading losses strikes me as fiction. If true, the rest of them are a bunch of idiots who are all losing their shirts. What's the most likely scenario? Let's just say there's probably a whole lot of fudgin' goin' on."

Primary Dealers' fixed income holdings have been rising, mostly due to their buying mortgage backed securities (MBS) along with some longer term Treasuries. Given that the PDs are on a MBS buying binge, what are the odds that the next round of QE will involve the Fed stepping in and taking MBS off their hands? .


Lee's chart above suggests that the large banks' non fixed income trading assets and the S&P move largely in tandem. 

About The Author - Ilene is the editor and affiliate director at Phil's Stock World with a fascination with the markets.  She also maintains a blog at Phil's Favorites.

The views and opinions expressed herein are the author's own and do not necessarily reflect those of EconMatters.

EconMatters, June 9, 2011 | Facebook Page | Twitter | Post Alert | Kindle