What will happen when QE2 ends in June?

With QE2 scheduled to end in a mere three months, no one’s entirely sure how the dollar and the stock market will respond, but there’s lots of evidence that it won’t be good.

A darkening cloud seems to be forming over the financial markets. With QE2 scheduled to end in a mere three months, no one’s entirely sure how the dollar and the stock market will respond, but I’m willing to bet it won’t be good.

QE2 continues to inject an average of $4.4 billion dollars every business day into the U.S. economy, according to Chris Martenson at GoldSeek. That enormous chunk of change has been wending its way into stocks, commodities and bonds.

And now, a series of well-timed media appearances by Fed governors across the country appears to be signaling to the market that the party’s due to end. The Philly Fed’s Charles Plosser is calling for interest rate hikes, James Bullard of St. Louis suggests that strong U.S. economic data could let the Fed wrap up QE2 early and New York’s William C. Dudley sees no reason why the program should continue after it ends in June.

The sheer scale of QE2 should be an indication of how deep our boots have sunk into the muck. Since the start of the Great Recession in 2008, Martenson points out that the monetary base has grown by some 300 percent. And yet, the unemployment rate is still hovering at 9.2 percent – a level we haven’t seen for 28 years.

The Fed has artificially propped up the markets and Martenson argues there’s going to be a whole lot of misery when the music stops in June – particularly since the crisis in Japan leaves few buyers for U.S. treasuries moving forward.

“If the Fed terminates QE on schedule, then I think a tsunami metaphor is apt,” Martenson writes. “First, all of the liquidity will drain out of the bay, leaving countries, governments, and institutions to flop about in the mud. Then the Fed will panic and resume the liquidity flood, feeding the wave that will rush back in to destroy the lives and portfolios of those who positioned their wealth in harm’s way.”

Not everyone agrees, though. James Dailey, chief investment officer of TEAM Financial Managers, tells TheStreet that he’s confident the Fed will raise rates slowly – probably even too slowly, and that should keep upward price pressure on stocks, commodities and precious metals.

“Even if we see tightening, that is no reason to not own commodities,” he added. “Central banks will be behind the curve. You can get corrections based on it being overbought now but the fundamentals are intact. Unless there is a global recession or one or more central banks find religion and develop a Volckeresque appetite for monetary tightening, we see negative real yields.”

An informal survey of experts as CNNMoney found that all but one money manager thought the end of QE2 would have a negative effect on stocks. The economy’s expansion, they argue, should buoy stocks even without the flood of easy money entering the markets.

I’m not so sure. There isn’t a whole lot of data to draw from, but we do know that Japan’s quantitative easing experiments 10 years ago typically led to market sell-offs when they ended. The same thing happened here when QE1 was halted. CNNMoney’s own chart illustrates the market sell-off that eventually led to QE2:

The experts might be telling us to put more faith in the strength of the recovery, but I’m just not convinced the recovery is ready to stand on its own. All we’ve got to go on is past experience. And I’ll take that over the educated guesses of the experts. Expect me to be in cash in June, watching from the sidelines and hoping that QE3 is just around the corner.

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1 thought on “What will happen when QE2 ends in June?”

  1. I have a web site where I give investment advise on penny stocks and stocks under five dollars. I don’t believe that the unemployment situation in the united states will improve anytime soon. advancing technology which greatly improves productivity without adding any new employees will keep job growth to a minimum’ in addition the outsourcing of manufacturing and service jobs to foreign countries will continue and even excellerate in the coming years’ and because of the tremendous over capacity of labor in the market place’ wages and benifit increases will be will be kept to a minimum. business owners will be the primary benifituaries of this trend not the employees of the company. this is a very disturbting trend. I would like those of you that own a business and have employees to at least think about the consequences of this negative trend.

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