And so it is finally here; QE3 has been effectively announced by the Federal Reserve today, with monthly asset purchases continuing via Operation Twist and expanding via further mortgage backed securities purchases. The goal: continue to drive long term rates down and continue to facilitate and / or put a floor under the critical mortgage market ad-inifinitum.
Basics of the QE3 Announcement
The basic gist of the QE3 announcement is the expansion of the MBS portfolio by about 40-45 billion per month via open market purchases. The Federal Reserve has made this announcement via Ben Bernanke’s remarks today – and in so doing has made an open-ended commitment to asset purchases for the Fed’s balance sheet. Readers can effectively expect for the next several years (language for low rates out to 2015 now) a floor under fixed income asset prices and as a result – similar securities based on those underlying assets. The net effect of this policy is designed to keep the critical housing market functioning in the face of continued high unemployment / underemployment and consumer credit deleveraging.
Our expectation was certainly a need for continuation of Operation Twist but were not convinced the Fed would act so close to an election cycle. Given the declining or unsatisfactory growth of the economy the Fed Chairman really had no choice but to act now or else face certain political backlash from The People. Markets had been climbing in recent weeks in full anticipation of this announcement and with the numbers finally here those traders who had taken positions (perhaps with leverage) have been taking every opportunity to cash out their winning positions (we call that distribution – selling winners into a rising and highly liquid market).
Trading Signals Indicator Marks Distribution Cycle
It does not take a rocket scientist to figure out what the initial impact of the QE3 announcement would be – asset prices (en masse) would rise. Beyond that initial spike, we saw in our favorite short term trading indicator a reversal and spike downward not long after the initial rise. Shortly thereafter the market (S&P 500) began to give back a chunk of its gains post announcement in a classic distribution pattern. Face it, with high leverage positions and illiquid markets day traders have to be careful as to when they pick their moments to unload in order to maximize profitability. This is one of the reasons we tend to advocate avoiding leveraged investments and go with alternative short term high yield cash based account investments instead – but to each his own as there is no right or wrong answer so long as the gains are accretive, right?
What to Expect Once QE3 Officially Starts
It is relatively safe to say that once QE3 officially starts we can expect pattern trading around the mechanics of the asset purchases to resume. Truth be told it really never stopped given the ongoing commitment to Operation Twist. It really pays to understand how these market operations work and the monetary mechanics that go into executing each daily (give or take) operation. We have been a party to watching these events on a daily basis since they first began in December 2008. Here we are 4 years later almost and still hardly anything to show for it. Still, the Federal Reserve would tell us to be thankful because we would be much much worse off without it. Hard to say with gas at $4.00 and rising with the winter heating season on the way, isn’t it?