Will QE3 Expectations Be Reset Next Week?

Includes: FXE, UDN, UUP
by: Kathy Lien

QE3 or no QE3 will remain one of the primary questions that investors will seek answers to in the new trading week. Although the rally in the U.S. dollar against the euro and other major currencies suggests that traders are lowering their bets on a third round of stimulus, the inconsistent movements in other markets indicate that many market participants are still undecided. A quick survey will show that expectations for QE3 are very malleable at this point, which is what makes next week's economic reports so important.

The Federal Reserve's beige book report, retail sales, consumer prices, housing market, and manufacturing sector numbers will all play a role in shaping investors' expectations for QE3. If consumer spending declines for the third straight month or consumer prices fall for the second month in a row, we will once again hear talk of QE3 in the third quarter, which would be bearish for the U.S. dollar. However, based on the consumer spending reports from the International Council of Shopping Centers and Johnson Redbook, we could see a small increase in retail sales. If that's the case, it would be positive for the U.S. dollar.

In many ways, consumer spending is just as important as the non-farm payrolls report because it is the backbone of the U.S. economy and accounts for 70% of GDP. The beige book report will provide a more thorough assessment of the state of the U.S. economy and can therefore also play a big role in reshaping QE3 expectations. For the time being, the verdict for QE3 is still out. Most economists and investors agree that the U.S. economy needs more stimulus, but they are not sure when it will happen this year -- if at all. According to the FOMC minutes, central bank officials are also exploring "new tools."

According to the latest U.S. economic reports, producer prices grew by 0.1% in June, which was the first increase in wholesale prices in four months. Economists anticipated another monthly decline in price pressures, but with PPI ticking upward the case for a third round of quantitative easing weakens. Excluding food and energy costs, PPI rose 0.2%, which was right in line with expectations. While inflation is still very low, the Fed will latch on to any reasons that would allow it to delay QE3.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.