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The Market Plays Along as the Fed Gets It Wrong

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The Fed has told the market that the economy is as bad as we all thought -- but the market rallies?

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Do you hear that humming sound from Washington? It's the US printing presses making money! The Fed launched QE3 yesterday with a material size behind it. The fact that they have started QE3 ahead of the election really surprised me. But the size of it does not. If you are going to show the political courage to make this move ahead of the November vote, then you better do it big to show that it must have really been necessary.

But was it necessary? Was it even the right tool for this Fed to use? I think the answers are no, and no.

The best analogy I can make? This is a doctor that can't figure out how to cure his patient and he is running out of ideas. So, the doctor gives the patient a shot of adrenaline. The adrenaline helps to improve all of the patient's vital signs, but the improvement is only temporary. The doctor is just hoping that he can buy himself enough time to figure out what is really wrong, or even buy enough time for the specialist to arrive and provide some real cure to the problem.

The Fed's decision to double the size of its buying program in mortgage backed securities (MBSs) will certainly help to keep interest rates low – especially in the mortgage market. Lower mortgage rates are certainly better for the housing market than higher interest rates. But the housing market faces headwinds that can't be overcome in a short time period, and this boost by the Fed has a short shelf life.

If the Fed believes that the housing market might improve and provide a boost to the economy in terms of new jobs, then they are putting too many eggs in the wrong basket. Historically, the housing market has been a leader that helps to pull us out of recessions. But historically, the housing market was never a bubble that got popped and acted as a major cause of the recession to begin with. That is our circumstance now.

The challenges facing the housing market are significant: record unemployment, shrinking wages, high commodity costs, too many homeowners under water, record number of foreclosures in process... and the list goes on. This move by the Fed will not generate enough job growth in the housing industry to make a big dent on our nation's unemployment.

I am sure the other part of the Fed strategy is to spur some risk capital back into the market that might create jobs. If they buy MBSs from investors, maybe some of those investors might seek to redeploy their assets into investments that generate jobs here in the US. I think this is just wishful thinking. After all, US corporations are not lacking for the cash on their balance sheet to invest in 'shovel-ready' projects. US corporations have record amounts of cash on their balance sheets. They are just choosing not to re-invest that cash right now because the risk/reward dynamic in the US makes them wary. The uncertainty in Washington is not helping either.
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No positions in stocks mentioned.
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