With this priced in, control of interest rates have now been lost by the Federal Reserve and are now completely in the hand of speculators, with new-born bond vigilante Bill Gross leading the pack. Why do I say this? Well, imagine for a second what happens if Ben Bernanke does NOT comply with the consensus view of QE3....
The interesting part is that an end to quantative easing would likely send everyone scurrying into treasuries for safety, as the now freely levitating stock market cannot keep floating without new stimulus. If there is no QE3, I expect money supplies to start contracting rapidly as credit freezes up and lending starts declining. In some magic world turned upside down, this would likely lead to interest rates going lower ..... just like Bernanke wants! The problem is, he doesn't want the deflationary effect of credit contraction to go along with it.
This is the Box that Bernanke Built. In order to "stimulate the recovery", he has to go about the counterintuitive act of raising inflation expectations by monetizing government debt, and simultaneously keep interest rates low despite this. My conclusion? The amount of paper that Bernanke will have to buy is going to be enormous, if he decides on an interest rate cap program. If he doesn't, the market will give a shriek of disappointment, send the dollar soaring and erase the entire "wealth effect" that QE2 created, while simultaneously kicking an already horrible sentiment for the economic future a few steps further down, upon which everyone will scream ...... oh, no - DEFLATION.
The US can play this merry-go-around until there is no middle class left, and the dollar is effectively toilet paper. It may take ten years, or it may only take one year. But at one point or other, it all ends. Very badly.
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