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Is the Fed Serious, or Is It Simply Trying to Scare Speculators?


Is the Fed going to eliminate QE3 soon, or is it just trying to slow the market?

Yesterday saw the release of the latest Fed minutes, and they revealed considerable dissention among committee members as to how long quantitative easing should continue, and whether or not it should be scaled back. There was even a proposal about whether to vary the pace of asset purchases on a meeting-by-meeting basis (talk about volatility!). The minutes seem to show a divided Fed who suddenly appears to be questioning its own policies, and the committee is presently less unified than we've seen over the prior few years. A review of the current program has been set for March -- so let's all Simonize our watches, and mark our calendars for March 20, at which time Ben Bernanke will hold a press conference in the aftermath of the Fed's two-day meeting.

The big question in my mind is whether this is "real" dissension, or simply the flip side of a coin we've seen from this Fed before. For the past several years, when we've been in between QE programs, the public-relations strategy was clearly to "keep hope alive" for new QE programs. Of course we don't need to talk hope anymore, because now we have QE-Infinity, which (in its present form, anyway) is effectively a huge green light for bulls, screaming that the market is endlessly back-stopped. The message has been: "Buy risk assets at any price, and we'll make sure there's always liquidity flowing in to cover them."

As a result, the present problem faced by the Fed is no longer "how do we keep hope alive?" Instead, the problem it faces is how to gain control of the monster it's created, and how to put the brakes on rampant speculation. We've traveled 180 degrees, from "Let's talk up QE and keep the market hopeful," to "Let's talk down QE and keep the market grounded."

Which brings me back to my original question: Is this simply part of its PR strategy? Or is the Fed genuinely having second thoughts? Obviously, I have no way of knowing, but I think it's a valid consideration. If it is having second thoughts, then that's a critical piece of information, and the market realizes that -- hence the sell-off yesterday. If this is simply a PR strategy, then this is a temporary scare.

This has largely been a Fed-driven rally since 2009. Without the Fed's "greater fool" purchasing power, it's unlikely risk assets would continue on their present upward course. This conclusion requires little in the way of speculation: Every time a QE program has ended, the market has sold off (plus an angel gets its wings). Of course, we do need to remember that QE hasn't actually ended yet, and may not end anytime soon. All we have right now is the "threat" of QE maybe possibly sort of ending -- and again, I wonder if this isn't simply the Fed playing the game of "verbal monetary policy tightening" the way it used to play the same game in reverse, when Bernanke would run around making statements such as, "My finger is on the QE button!"

Nevertheless, perception is often reality for the market, and with the release of yesterday's minutes, we do have a watershed event that clearly shifted at least the near-term sentiment. In fact, yesterday evening, a headline on Market Watch read: "Dow Suffers Second Biggest Drop of 2013." To quote one of my favorite lines from the old TV series M.A.S.H.: "That's roughly comparable to being the finest ballerina in all of Galveston."

While I make light of the temptation to jump all over yesterday's dip as the Eighth Sign of the Apocalypse, there are actually a couple issues we'll cover from a technical perspective which tell us that bulls do need to stay on high alert here.

The first revolves around that fact that the most recent breakout failed to reach the short-term upside targets (S&P 500 (INDEXSP:.INX) fell about four points short). The near-term pattern whipsawed, which indicates that sellers came in earlier than they would normally be expected to -- and this is sometimes the type of behavior we see near larger turning points. The chart below shows the whipsaw of the green triangle pattern, and the failure of multiple up-sloping trend lines, along with the penetration into the support shelf in the 1514 zone. If support fails at 1509-1510 the odds are good we're headed to retest the area highlighted by the blue box.

The odds presently favor a bounce in the next session or two (which could be viewed as a selling opportunity by the nimble), followed by new lows.

Click to enlarge

I've largely ignored the bear counts since 2013 began, because up until now, I saw no reason to be bearish at all. It's rare that I have enough confidence in my preferred read of the market to essentially publish only one count, but it makes it much easier for people to follow along with the outlook when I'm saying "the two main options I see here are higher or higher."
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No positions in stocks mentioned.
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