9/5/12 3:24 PM – Is QE III Priced Into the Market?

The answer to the above question, according to the talking heads on TV, is “yes.”

But, while the stock market does react quickly to new information the stock market has really gone nowhere since spring. There was a rally starting June 1 that gained 8% after a two-month drop but that was likely in response to ECB President Draghi’s statement that the ECB would do whatever was necesssary in Europe.

Look at the yields on 10-year US Treasury bonds. Since April, the yield has dropped from 1.8% to 1.6%. It is up a little in the last couple weeks. Is this due to the bond market pricing in lower yields that would be expected with quantitative easing? Or, is the drop in yields due to increasing demand for US Treasuries from Europe as the European recession has deepened and the Spanish bank and bond problems have gotten worse? No one really knows.

If the bond market has priced in QE III already then Ben Bernanke’s hinting at another round of easing has worked already and there is little left to accomplish in bond yields. It may be that stocks have basically broken even for weeks now by balancing the prospect of QEIII with slowing growth around the world. If that is the case and the jump from more quantitative easing is alreay in the cards then what is left is slowing world growth and that would be a negative for stocks.

I am very interested in what happens over the next week in response to an ECB announcement tomorrow. There are three scenarios. If the market loves it and goes up, that’s great. If a short pop gets sold off, then that is not very encouraging. If the markets are immediately disappointed then only a coordinated announcement by the Fed, ECB and other central banks would push markets up. When the only things pushing up markets are announcements by politicians and central bankers, things are pretty thin, indeed.