QE2 is expected to end in a month, but there is still high uncertainty on the potential market direction for the summer given the macroeconomic environment.
There has been a close link between quantitative easing and stock prices. Since the announcement of QE2 last August, the S&P 500 has gained almost 30 percent. A similar gainwas associated with QE1. The dollar has been in decline with the bond purchases from the easing until this month. Strong monetary stimulus lead to a dollar sell-off.
Now we have a more complex risk-on environment. Stocks have moved sideways. The dollar has recovered losses, albeit partially due to Greek problems, and bonds have rallied. With greater certainty that QE3 will not come, the dollar strengthening, lower rates from declining inflation fears, and a more complex equity market seems like the right story. This no monetary stimulus story seems to have taken hold of the market, but the simple risk-on tale is not so easy to deal with given the current economic environment.
Economic growth for the first quarter was only 1.8 percent and the latest economic news does not show that we will have a fast acceleration in the economy. Housing is still a problem and the potential for a fiscal crisis with the debt ceiling vote is real. There may be a need for monetary stimulus given the lack of fiscal help and the fact that core inflation is still very modest. We know there is no QE3 now but the possibility may exist if we see slower economic growth. Without clarity on policy, there will be a monetary ease overhang. Bad numbers, possible help from Bernanke. Good numbers, no help. The dual role of the Fed generates more policy uncertainty.
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