QE

The Fed announced plans to buy up $300B in Treasury bonds. Now to be clear, the Fed is not buying up existing holdings of Treasuries, but is instead planning to be a buyer in imminent debt issuances by the U.S. Government. This means that the Fed still has one arrow left in its quiver.

I am grappling with the timing of the Fed's move. The stock market sustained a rally until the news of the Fed's plans hit the net. Investors were starting to feel the bottom. Now, the uncertainty that has dogged the market for over three quarters is back.

Why now? A strong dollar in the short run is still a good thing. It keeps energy prices low and provides a stable backbone to the world economy. A strong dollar maintains the sense of safety inherent in Treasury bills and supports confidence in the U.S. as a government and as an economy.

According to form, QE is implemented when a zero interest rate regime fails to stimulate economic activity. The central bank then needs to scare people out of currency and into assets, and the best way to do that is to weaken the currency. So, if the market is rallying, which signifies a return to risk-taking, then there is no need to scare people into buying assets. Contrariwise, a rational investor (are there any rational investors left?) would interpret QE in the midst of a rally as a signal that the economy is still too dangerous for play.

Furthermore, for the stimulus to be effective, stuff needs to be purchased. With a weaker currency, the stimulus money will buy less. And who believes that the difference will be made up by increased exports?

"Hello, my name is liquidity trap."

Unless investors perceive the Fed's move as immaterial, or a signal that the worst is behind us (meaning that the economy is leveled out and we can move on to inflating our debt away), then the market rally should continue. If the Fed's move is interpreted as a move to correct even greater underlying problems (e.g., a fear that there won't be enough buyers of U.S. debt; i.e., China; cf. Italy), then investors will return to the sidelines, content to lose a little against inflation instead of losing a lot against a still-retreating market. Where does that leave us? With tiptoes tickling the iron jaws of a liquidity trap.