Handicapping the Fed in general and the odds of QE3 was the major parlor game in the market for awhile, providing a framework through which all incoming economic data was evaluated. What will everybody do now that the Fed seems to have used up its last bullets in one go?
Stocks love liquidity, and Thursday’s open-ended liquidity enhanced measure pushed the markets sharply. This morning’s positive Retail Sales and benign CPI reports will likely add to the lingering positivity from Thursday’s Fed inspired gains. We will likely see above-average trading action in the shares of Kraft and UnitedHealth (UNH - Free Report) , with the health insurer replacing the food and snacks company in the Dow Jones index.
A few things stand out from the Fed action. First, the Fed is throwing everything at its disposal to increase economic growth and job creation. They not only came out with a new open-ended housing-centric bond purchase program, but extended the zero-rate guidance for another six months and retained Operation Twist. They were at the end of the monetary rope to begin with, but they've literally used up everything now.
Second, the Fed is now prioritizing the full employment part of its dual mandate over the price stability piece. This morning’s benign-looking August CPI reading provides an explanation of why the Fed would do that – inflation is just not much of an issue at this stage. But the Fed is going a step ahead and guiding towards being very accommodative even after the jobs picture starts improving.
Third, the rising prices of stocks and other asset classes may not be the by-product of the Fed’s easy policy, but one of its key goals. Bernanke alluded to the positive effect of higher stock prices through the wealth effect mechanism. He was also at pains to emphasize that monetary policy was not the panacea for all the issues facing this economy. Uncertainty on domestic fiscal issues (fiscal cliff) and the global growth concerns are the bigger issues for the economy than lack of liquidity.