There are too many moving parts for the outcome of FOMC meeting to be a foregone conclusion. Since the disappointing August jobs report, the risk of a new round of asset purchases has increased and this has contributed to the risk-on environment, which of course has also been driven by the ECB. While this had led many to conclude the QE has been discounted, there are still many key unknowns.
First, though, let's rule out some possibilities, like a U.K.-styled funding-for-lending program and a reduction in the interest paid on reserves. In its communication, it seems clear the Fed is not prepared to take such measures now.
Second, let's acknowledge a couple of things to which there is little doubt, like pushing out the rate guidance from late 2014 into 2015 complimented by reduced growth forecasts, while contending that inflation expectations remain anchored. Even if it is only pushed out to mid-2015, the least anticipated, the Fed may drive home its point by underscoring that it will continue to maintain an extraordinarily accommodative stance even as the recovery gains traction.
Now let's turn to the unknowns. Assuming QE, there are several issues. What will it buy? Given the communication, there is a general expectation that mortgage-backed securities will feature prominently, perhaps even solely. How much will it buy? The benchmark here is QE2, which was for $600 bln over 7-8 months.
There seems to be some desire for greater flexibility and this could come from a smaller program carrying over into early next year. If it weren't for the perceptions of the political awkwardness posed by timing of the next FOMC meeting a fortnight from the national election, it might be more acceptable to make its purchase decisions on a meeting-to-meeting basis.
What about Operation Twist? Most likely the Fed will continue to move to complete Operation Twist and a new program to buy MBS and/or long-term Treasuries should not conflict with it.
The most important question, however, is how will the markets respond?
Given the rally in risk-assets in anticipation of QE, the market is prone to "buy the rumor sell the fact" type of activity and this would be dollar positive and equity market negative. There is also scope for disappointment with the amount to be purchased or the time frame and that could also lead to a risk-off, dollar-supportive move. The euro has not only taken out the 200-day moving average, it has now retraced nearly to the tick 61.8% of this year's decline (~$1.2935).
While some may be tempted to pick a top in it, looking at a host of technical indicators, there still does not seem any evidence to indicate a top is at hand. That means that there is not an obvious place to put a stop to minimize one's losses. Moreover, there is nothing really special about this year's high. The last significant high the euro made was in May 2011 near $1.4940. The 38.2% retracement of that move comes in near $1.3150, for example.
Some suggest that given the likely expansion of the Fed's balance sheet and the ECB's OMT, gold is an alternative to paper money. Yet most recently gold has been trading in conjunction with risk assets. For example, the correlation of returns (percentage change) in gold and the S&P 500 over the past 60 days stands at the upper end of this year's range (0.51). As recently as June, there was an inverse correlation between gold and the S&P 500.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.