This week, we saw both the European Central Bank and the Federal Reserve deliver massive amounts of stimulus to the markets.
The ECB is now backed by the 500 billion euro European Stability Mechanism facility, which has been ratified by the German parliament. This is a game-changer for Europe, as now it is finally moving toward a federalist system, similar to the one in the United States. This measure has been successful in bringing down the bond yields for Spain, Italy and Ireland to a very manageable level. And it is likely that those central banks might not even need to tap the ESM.
The big surprise this week, however, came from the Federal Reserve.
The Fed has decided to go all-out in fueling the next massive asset bubbles through its QE3 bazooka. The Fed announced plans to buy $40 billion worth of mortgage securities per month on an open-ended basis, while continuing to reinvest its income from the securities purchased during QE1 and QE2.
The following statement from the Fed shows its clear intent to support its mandate of full employment. But I fail to see how it will manage to do that "in the context of price stability" while creating asset price inflation through unabashed QE programs.
If the outlook for the labor market does not improve substantially, the Committee will continue its purchases of agency mortgage-backed securities, undertake additional asset purchases, and employ its other policy tools as appropriate until such improvement is achieved in a context of price stability.
This new move by the Fed is unleashing massive amounts of money into the risk assets. Markets will now believe that, between the ECB and the Fed, all tail risks to the markets have gone.
In other words, this could mean that all the money that was hiding in the safety of U.S. Treasuries will now leave the Treasury markets and flow into equities and commodities.
If so, I would not be surprised to see a parabolic move into year-end in both gold and equities that could take the S&P 500 to 1,650 and gold to $2,000 per troy ounce by year-end.
Now here is the dangerous side to this equation. This rally will also lead oil and grains to new highs, which will results in higher gas prices at the pump and food prices at the grocery store. While employment and wages are still low, this will hurt the working class.
This massive and irresponsible Fed stimulus package by Ben Bernanke & Co. will make the rich richer by fueling their asset portfolios and bringing loads of misery to the poor, who will find it harder to make ends meet.
Besides the poor, this latest move also declares war on the retirees or those who subsist on fixed income returns from bonds. With the Fed's monetary policy stuck at zero for another three years at least and more Federal money creating artificial demand for fixed income assets, yields will not rise for quite a while. This means that the coupons on newly issued government and agency bonds will be stuck at below inflation rates.
Another debilitating aspect of the latest round of QE is that by removing coupon generating bonds from the monetary system, it reduces the amount of money in the economy, thus reducing aggregate demand.
In summary, QE will reduce net savings of U.S. dollar holders and increase paper wealth in terms of higher equity market valuations.
While the initial reaction of the markets has been to sell the U.S. dollar, fewer U.S. dollars as a result of QE will result in the dollar eventually rallying hard, especially against the EUR. My target will be around 1.3500 before EUR/USD starts heading back down towards parity.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.