The markets are as usual focused on every last word dropping from Ben Bernanke's lips. On confirmation that no QE3 is forthcoming as of yet, the market dropped Tuesday, but recovered through the day and Wednesday, with the S&P 500 (SPY) registering a 0.67% move upwards, the Nasdaq (QQQ) registering a 1.12% run, and the Dow (DIA) rallying 0.81% on the day, finishing above 12,900 and giving bulls hope of a break above the 13,000 level. Gold and silver slipped slightly on the lack of further easing.
Bernanke's fundamental problem is that further QE has diminishing returns, and while current economic data is bad, it's not abysmal. While the initial QE helped the economy, repeated injections of cash directly into the bloodstream are actually damaging, according to David Einhorn. Even worse, many analysts are predicting QE3, meaning that implementation could lead to muted-at-best results.
The way Bernanke looks at it, he's down six in the fourth quarter with only one timeout left. Crouched behind the bar with bullets flying all around him and only one cartridge left in the chamber of his six-shooter. Pick your analogy. Point is, would you want to spend your timeout/bullet until you absolutely have to?
The Wall Street Journal might've made the understatement of the decade when they said:
Okay, so Fed Chairman Ben Bernanke didn't exactly say "we're breaking out the QE3 tomorrow" in his Congressional testimony this morning, and that was very disappointing to the market.
Despite headlines proclaiming Bernanke "wants to ease more," in reality, his actual words in the "Monetary Policy" section of the prepared statement gave little indication of easing. See for yourself - you can read them here. The word "easing" doesn't appear once - although "ease" does, in context of Operation Twist. The word "purchase" appears once in the phrase "purchasing power," and twice in regards to the current Operation Twist MEP (Maturity Extension Program). Again, not a word about future easing.
I would suggest investors hoping for QE3 prepare to be disappointed by the upcoming FOMC meeting. It's in Bernanke's best interests to "string the market along," per se. The longer he can go without announcing further easing, the longer he gets to keep his last bullet.
On a lonesome bright note for the market, investors are more fearful than they've been since Lehman, according to Treasury yields. The "flight to Treasuries" story we've heard over and over again is so strong that even at record-low yields, the recent 30Y auction fetched a 2.70 bid-to-cover ratio. Why is this widespread investor fear good? Well, it speaks to the fact that nobody wants any part of risk right now -- yet the S&P 500 has doubled off the post-financial-crash bottom, in an environment where risk appetite is very low. As I've predicted before, a return of "risk-on" trading spurred by positive economic news from either the US or Europe could spur another strong rally like the one we saw this winter and spring. It's noteworthy that this rally occurred without the help of QE from Uncle Ben, although the rally might have had a little assistance from the ECB's LTRO program.
In conclusion, Bernanke sees the same thing he's been seeing for months: a risk-averse and highly volatile investing environment where the macroeconomic outlook is struggling but not collapsing. Each new economic report isn't great, but it's a four yard catch-and-run-out-of-bounds that at least gets the clock stopped. Until the market finally runs out of downs - or runs into a tackler that keeps it in bounds - don't bet on Bernanke calling his last timeout.
