Will QE2 still be working if the U.S. Stock market takes a swan dive?
It’s a timely question, with the Federal Reserve scheduled to hold a regular policy meeting Tuesday — on a day when stocks are down 11% in Japan, 5% in Germany and 3% in Hong Kong and the U.K.
The U.S. Stock market has yet to open Tuesday, and its selloff Monday was mild. But worse could be in store: the S&P 500 has doubled over the past two years, prompting many observers to say at least a 5%-10% correction is overdue.
Whatever stocks do, the question is what lesson Fed chief Ben Bernanke might take out of a stock market correction. After all, Bernanke and other members of the Federal Open Market Committee have been saying rising asset prices are a sign that their policy of buying Treasury bonds has been working.
Up till now it has been hard to argue, given the timing of the surge in the prices of stocks and commodities. They took off in late August after Bernanke signaled the Fed wouldn’t let U.S. Inflation fall any further. Other signs of a gathering economic recovery, such as a jobless rate below 9% for the first time in two years, could also be taken as a sign that QE2 is helping to stabilize a weak economy.
But skeptics of the policy have started warning about the wall the markets might hit in June, when the Fed’s bond-buying program is scheduled to end. Without the Fed soaking up $75 billion a month in Treasury issuance, they contend, bond yields could shoot up, undermining the weak recovery and causing a repricing in other assets.
If the flight from risk spurred by Japan’s disaster spreads to the United States, that repricing could happen sooner — at which point it would become harder for Bernanke & Co. To point to the so-called wealth effect of rising stock prices as a success story.
Of course, with Japan in severe distress and last week’s U.S. Consumer confidence number coming in cool, the case against winding up central bank support for the bond market may be getting easier to make, regardless of whether QE2 is deemed to be hitting on all cylinders. And lower commodity prices could bring a welcome respite in the inflation warnings we’ve been hearing 63 times an hour lately.
The Fed’s statement Tuesday isn’t likely to address any of this, of course. Even so, an ugly selloff in the stock markets could give Bernanke a lot of explaining to do.
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