Traders contemplate Fed’s options for QE3

Will they are won’t they?

The bar has been raised and now it is up to the Federal Reserve to meet or exceed expectations. Many in the marketplace feel that some form of quantitative easing may be in the market and to give the Fed’s soon to be announced stimulus plan its best chance to work, they are going to have to wow us!

While just the threat of European Central Bank buying may keep the Spanish and Italian bond vigilantes at bay, it is going to take more from the Fed to keep the market on an upward trajectory. The United States heads toward an election with an anemic jobs market as we merrily drive towards our fiscal cliff, it is imperative that Ben Bernanke and his crew not disappoint.

To buy bonds or not to buy bonds, that is the question. While the market gets out its special glasses to be wowed by QE3d, the moves the Fed might make may be a bit more subtle. Many believe that the Fed will only renew their commitment to keep rates lower for an eternity or at least until the Cubs win a World Series. Already our friends at the Fed have told us that we are going to see exceptionally low levels for the federal funds rate at least through late 2014 and now many believe that we might push that back through late 2015. In the thinly traded Fed Fund Futures we are seeing the odds of a rate cut getting pushed further in the curve. As of 5:27a.m. central time, the only chance of a rate increase is all the way back in the July 2014 futures which is telling us right now that we would see an increase at the June 2014 meeting. Yet we are already seeing bids on the board that would take the increase out of contention. Then as you sift through the bids and offers, we could very easily with just a few trades, push that back to the February 2015 Fed Fund Futures which would be that Jan 2015 meeting.

The other possibility is that the Fed goes bond buying crazy and takes a clue from European Central bank leader Mario Draghi and announces an unlimited bond buying blitz. In the past when the Fed has announced QE, it has always reported exactly how much they would buy and when they would stop. Of course if the Fed comes out and says that, they may come in at any time and buy any amount of any type of bond and anytime in unlimited quantities, thus putting the fear of God into anyone who dares to believe that US yields could rise. At any time, at the whim of the Fed, they could flood the market with freshly printed dollar bills crushing yields and returns if the Fed so desires.

They could also double down on the Twist or as I call it, the Chubby Checker strategy. The Twist is the Fed manipulation of the yield curve where they sell bonds on the short end and buy on the long end in an effort to keep rate expectations low for the long term to encourage business and others to make long term investments that will grow the economy over the long run. The Fed has already announced that they will twist the yield curve to the tune of $267 billion by the end of the year in $45 billion dollar monthly installments. They may just decide to double that or even triple it in order to anchor low rate expectations in the mind of traders, come hell or high water and even fiscal cliffs or an election. Or they just may give up on the twist all together and go bond and mortgage back security crazy across the yield curve.

Speaking of the election, some feel that the Fed will wimp out and just give fiscal policy a short-term blitz, just enough to get us through November. 

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