Fed's QE3 Is the Drug the Market Craves

By Robert Holmes
TheStreet
Aug. 10, 2011

BOSTON (TheStreet) -- The Federal Reserve has turned into the ultimate pusher, and quantitative easing is the drug that investors want badly. The question now is whether any good would come of allowing the central bank to continue to enable the markets.

Witness Tuesday's dramatic sell-off following the latest statement on interest rates, which was followed by a dramatic surge into the closing bell and an equally dramatic plunge at the open Wednesday. The Dow Jones Industrial Average, which rocketed higher by more than 250 points in the last half hour of trading Tuesday, gave back that gain and more.

"You have effectively taken those gains away and we are where we traded yesterday before the Fed announcement," says Paul Nolte, director of investment with Dearborn Partners in Chicago. "Should we have rallied 400 points on the Dow? No. We're right back to focusing on debt issues and the unrest in England. Those things below the surface are indicative of a larger problem that we aren't solving."

However, investors still believe in the implicit guarantee, or the so-called "Bernanke put," that the Fed will purchase Treasuries in order to keep prices afloat. In its statement, the central bank said it will leave interest rates low until mid-2013 as economic growth has been "considerably slower" than the Fed expected. [...]

"The markets are addicted to that heroin, so to speak," says Lance Roberts, chief strategist at Streettalk Advisors. "The markets know they have that 'Bernanke put' in place. You didn't have a direct statement in terms of 'we're going to start QE3.' Saying that the economy is weaker than they anticipated is a set-up statement for QE3."

The expectation now is that Fed Chairman Ben Bernanke and the central bank will follow the same script as 2010. Last year, equities sold off sharply heading into summer as economic activity weakened. The Fed at first held off from promising more quantitative easing before Bernanke made a speech in Jackson Hole, Wyo., during the Fed's annual symposium. Investors now expect a sequel one year later, with Bernanke set to address the Fed conference Aug. 26.

Read More