Stock Market and Commodities Traders Front Run the Federal Reserve

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A few months ago the real estate futures market was forecasting a bottom for real estate in the second quarter of 2010 so now they are downgrading their forecast for real estate.

To me that means that the overall economic picture for the next 6-12 months is actually worsening instead of getting better.

But the stock market has been going up the past few weeks.


A lot of people think its because of the upcoming Congressional elections. If you listen to FOX News that is all you’ll hear about. But I think there is something more important that traders are looking at.

You can sum it up in two words – quantitative easing.

Quantitative easing is when a central bank prints money out of thin air and uses that money to buy government bonds, mortgages, and junk bonds from banks and other financial institutions, in the process they expand their balance sheet and give banks excess reserves which they hope they will lend out and stimulate the economy as a result.

The problem is that QE is a very difficult policy to implement. The risk is that a central bank engaging in QE buys too many securities and then creates inflation – even hyperinflation is a danger. The other risk is that nothing happens and instead of lending money out the banks just sit on it. When that happens investors and businesses lose even more confidence in the economy and lose any hope that the government can force it to grow. In my view the latter is a much greater danger than the former in the current situation.

We already saw the Fed engage in QE in 2008 and it had no impact on the economy. It helped banks, but no one else. Japan’s central bank used QE in the early 2000’s to no effect.

I first talked about QE in the August issue of this newsletter and said that it would begin to be an important story to focus on. In the long-run I didn’t – and still don’t – think it will have much of an impact on the economy, but it has captured the minds of traders more than I ever thought it would. It has helped the market more than I had originally expected.

Bradley Willet of Fallstreet.com points out that the current rally in the market began once Federal Reserve Ben Bernanke gave a speech in which he suggested that he would use quantitative easing if the economy continues to weaken.

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