Please Note: Blog posts are not selected, edited or screened by Seeking Alpha editors.

Fed QE2 Reverse Pivot?

|Includes: FirstFed Financial Corp. (FED)

Earnings are generally improving across the board at companies. Unemployment looks to be stabilizing in the mid-to low 400Ks and there are some tentative signs that it could be moving towards improved figures. Leading economic indicators point higher or remain unchanged. Banks are lowering loss reserves. The republicans look poised for significant political gains amid a highly populist campaign that repeatedly demonized TARP and financial bailouts. Commodities have exploded, gold continues to boom higher and China recently imposed some surprise inflation measures.

Amid this backdrop, a divided Fed appears to be embracing a second quantitative easing approach which the market has responded to by bidding up the market and certain attendant riskier assets.

However, I've got to wonder, given the deeply unpopular nature of the first QE and the signs of an economy hanging tougher then what was predicted, could the Fed be satisfied with just a jawboning approach to the economy and refuse to fully take the step to QE2?

Much to my (and a lot others surprise), we haven't hit Recession Part II, we haven't fallen off an economic cliff and approximately 90% of the US continues to be employed, albeit at lower real wages then they may be accustomed to or in jobs asymmetric to their skill sets. Even if the Fed's non-partisan nature, no one would accuse them of being eager to introduce a highly controversial approach that will introduce billions of new liabilities to their balance sheet, likely weaken the dollar and potentially unleash the inflation genie from his heretofore stable bottle, especially since the economy and the market continues to tenaciously hang on.

So could we be heading to a scenario where the Fed, contrary to previous statements either declines to pursue QE2 or pursues an action that is surprisingly subdued? I think the chances are higher than what has previously been discussed. In addition, I think such an action would likely produce a political and economic reaction that would be positive and lead to improved public and market confidence and "animal spirits", i.e.-if the Fed, with their access to economic data and analysis is confident enough not to introduce QE2, maybe I should re-consider my own analysis to see if I agree with this more positive tone. 

It is also a message that would be supported politically, both by the democrats who could crow about their fiscal stewardship and by republicans, who could either crow about introducing a climate of fiscal responsibility or, at the least, be forced to be muted in their criticisms as they've made controlling spending the crux of their campaign.

The most interesting thing to me is what would develop from such a move. I think the markets, after some surprise and subsequent churn in the indexes, would move higher, embracing the theme of emerging out of the recession. I suspect the move higher would be broad based, over equities, government bonds and the dollar.