Investors Are Predicting Another Round of Quantitative Easing

We might be returning to the days of “bad news is good news.”

It’s been well documented by us and others that all three rounds of quantitative easing (QE) did was to prop up financial assets, and artificially at that.

Recently, stocks have been trading as if the Fed plans yet another round of its bond buying program. Bad economic data makes it more likely that the Fed will try to stimulate the economy again, hence propping up stock values.

Bank of America has offered another interpretation. They noted that short interest had recently risen to levels not seen since just before the collapse of Lehman in late 2007, and that the recent rally was due to short covering.

Whichever one is correct, it doesn’t really matter. Both scenarios could result in a short-lived rally and a severe correction. And a short-term rally is likely how the smart money is seeing it. I doubt they see it as a new bull market driven by good earnings and an improving economy… because both of those are in short supply!

At this point, the Fed will likely do nothing to raise interest rates. With each new data point, a rate hike before the end of the year becomes less and less likely.

The minutes from the last Fed meeting (released last week) confirmed the overall theme of “wait and see.” Richmond Fed President, Jeffrey Lacker, thought rates should be raised, but the rest weren’t so sure.

The Fed chair, Janet Yellen, stated the same in her press briefing. The minutes indicated the Fed was worried about the lack of inflation, but believes we are on the way to full employment. I guess it was too early for them to react to the dismal September jobs report.

It was also interesting that the Fed held off on hiking rates because of global risks, mainly out of China. Since China’s markets were tumbling and causing panic elsewhere, the Fed thought it prudent to hold off once again.

Overseas troubles are here to stay. They aren’t “transitory,” a popular word in the Fed’s vocabulary. So the message here is that we shouldn’t expect a hike if there’s any chance of a market sell-off anywhere in the world.

Yields are virtually unchanged since the end of August (see chart below). Since the Fed is reacting to economic data and doesn’t seem to be planning to act ahead of possible inflation or move to normalize rates, the market is reacting to the data as well.

See larger image

Not only have rates not changed much, but an interesting technical pattern has developed.

Note the head and shoulders pattern above. This pattern suggests long-term Treasury bond rates should drop down at least back to the 2.70% level, and possibly much lower.

You can extrapolate that to assume the stock market’s in for another selloff. But on the interest rate side, Dent Digest Trader readers are poised for an upcoming drop in yields, which appears to already be starting.