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Charting a Course Balancing Open-Ended QE and the QE Asset Reflation Correlation Trade

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The big trade in 2013 might not be about the effect of a fiscal policy debacle; it might be about the effect of a monetary policy debacle.

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Most investors who are buying the QE asset reflation trade are focused on stocks and commodities which are most sensitive to dollar devaluation, but perhaps there is no asset that has been reflated more than US Treasury bonds. Not only are they the obvious target of Fed intervention, the excess dollar liquidity being created also has created excess demand for dollar assets.

It will be an interesting FOMC meeting on Tuesday because since launching QE III at the previous meeting, nothing that you would assume to reflect this reflation (including Treasuries) has responded as expected. In fact you might say that many assets have actually deflated. Here is where it gets even more interesting in what could define the trade for 2013. Is it possible that both stocks and bonds go down at the same time?

The Fed could potentially be a victim of their own success. By being so egregious in their attempt to manipulate the market pricing mechanism and by also boasting about it they have put themselves in a box. If and when the market doesn't behave the way investors think it should, at least when the Fed is inflating, investors will start to lose faith that the Fed is in control. Imagine if the assets that the Fed is trying to reflate all start falling. If that happens that could be a very dangerous situation for all markets including the bond market and the US dollar.

Most investors are looking toward 2012 worried about the results of the election and whether the fiscal cliff gets resolved. These are the known risks. The unknown risk is what I am worried about. To me that is how and when QE comes undone. The big trade in 2013 might not be about the effect of a fiscal policy debacle; it might be about the effect of a monetary policy debacle.

Twitter: @exantefactor
No positions in stocks mentioned.
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