To QE, or not to QE

You saw the possibility early that they might stop QE 2. They are floating balloons of policy change, and Geithner's sales pitch to the banks suggests that they are trying. But I just don't think they will get away with it, for all the consequences you articulated: rising rates would hurt stocks, the economy would tank, and the weak economy would get weaker. It might help the dollar, but the dollar has not collapsed at a level requiring the Fed to protect it.
Let's see if the discussion by the Fed affects the markets as badly as the QE 2 discussion affected markets positively before the actual purchases. The 10-year Treasury bond dropped to 2.4% or so in August on just talk, and is a full % above that on the actual big purchases. If the talk scares the market (rates rise and stocks fall), I bet they extend QE 2 or diminish it slowly. They must be looking at the calendar for election year and will want to turn on the fire hose of new money printing at least 6 months or maybe a year before the election.
I wrote about all this over a year ago, explaining that the federal government deficit is too big to be absorbed by anybody but the Fed, and that they would do what came to be QE 2. The deficit hasn't changed, so my prediction is that even if the Fed stops buying Treasuries for a few months, the bad reaction of markets will force them right back to the money printing press.
Absent that, the obligations to pay interest on the debt at higher and higher rates will make the deficit so bad that the dollar really crashes. There is no way for the Fed to stay out of the business of bailing out the federal deficits for more than a quarter, in my opinion, and I'm still not expecting they can really pull that off. - Bud Conrad

While I agree the Fed is cornered and has no choice but to continue quantitative easing ad infinitum, talk and action of temporarily ending QE policies could tank equities--including the commodities reflation play.  Because a stock market crash will weaken an already fragile economy, I believe the Fed will have to reinstitute QE at some later point in time, which would enable another rally in equities, especially resource companies--and including precious metals mining shares.

The Fed has to do everything in their power to contain rising interest rates, because if rates rise appreciably, the United States of America would be bankrupt overnight due to our humongous debt levels.  QE extends and pretends the illusion of solvency--at least until the next Administration is voted in--whenever that is.

In summary, don't be surprised if the Fed announces the end of QE 2.0 in June, causing markets worldwide to collapse in reaction.  However, seeing that experiment fail, the Fed will have to reverse course again and reinstitute "stimulative policies", flooding equities and the bond markets with massive liquidity.  Wash, rinse, repeat...

The alternative scenario is if the Fed continues QE uninterrupted beyond June, as the doves within the Fed override the hawks again.  Either way, QE is baked into the cake, interrupted or otherwise.   Long-term, this remains bullish for precious metals, even if there are clouds on the horizon short-term.

What are the investment thesis ramifications?  Taking partial profits on outsized gains may be prudent--with an eye towards re-entering the precious metals complex at lower prices.  Aggressive traders may even short the market, but be forewarned that shorts have been torched for two years trying to time the market, anticipating a drop despite accommodative Fed monetary policies.  The Bernanke Put has been in play for 2 years now.  Don't fight the Fed is a truism, especially in this age of surreptitious market manipulation.

Having said that, if the Fed follows through with tightening, it makes sense to follow their lead and ease up on the accelerator pedal.  Ultimately, it will merely be jawboning, and they will have no other choice but to resume QE.  This will catalyze the next nominal rally in equities, and a surge in commodities.

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