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Yesterday’s huge market surge was largely attributed to the idea that QE3 is on the table.  This was expressed by several of the large banks including Goldman Sachs who said:

“the largest number since 1992–the committee adopted an even easier policy stance than expected: first, the committee now anticipates that rates will stay on hold “at least through mid-2013.” Second, the committee effectively signaled an easing bias saying that it is prepared to employ additional easing steps as appropriate….In our view, this leaves open the possibility of further asset purchases (“QE3″) should the economic outlook deteriorate further from here.”

I obviously had a bit of a different take.  I viewed the Fed’s comment as an admittal that the US economy is in an extraordinarily odd recession that is likely to result in continued economic weakness in the coming years.  One could also take this to mean that QE2 did not have the desired impacts that the Fed had hoped.

From a market perspective, I think it’s very important to make some distinctions.  I believe I have shown ample evidence proving that QE2 was not very effective.  As I suspected at several points during QE2, equity buyers were largely banking on the positive effects from a program that did very little in reality.

The bottom line: we have to be very careful chasing rallies on rumors of further QE.  If QE2 did nothing more than create price distortions based on misconception then we have to conclude that it’s risky to chase further rumors of QE based on the hopes that further easing will translate into real economic growth.  Of course, I’ll take any new QE announcements as they come and try to offer any insights possible, but this environment requires great prudence and I don’t believe rumors of QE3 justify rally chasing.  Instead, we should continue to focus on the real economy and not the voodoo economics of the Federal Reserve.

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