Bad news is good news

The title of one of my previous blogs was 'No news is good news' and it mentioned the market's reaction to what was actually nothing new. The blog dates 20 September: just after the Fed's remarks that the economy showed no substantial signs of improvement and they would wait and see what would happen with economic growth in the coming months. Market sentiment was positive, although there was in fact nothing to be positive about: the outlook was just as bleak as before.

Today, the outlook is just as bleak, if not worse. However, the Fed is seriously contemplating QE2. Good for the stock markets and commodities and for these markets, a substantial amount of the by-markets-desired-$1trillion-at-least-of-QE2 has been discounted in market prices. A poor nonfarm payroll number last Friday made markets more confident that the Fed will give them 'their money' and subsequently, stock markets rallied. Hence, for the markets, "bad news is good news".

However, in a speech of Dallas Fed president Fisher, Fisher hinted at markets being overly confident about Fed starting a second round of quantitative easing. Payrolls are not expanding, because businesses as unwilling to hire as they experience too much uncertainty regarding future taxes and regulation, but they are aware of the fact that some day in the future, taxes will have to be raised to finance the huge government debt. In this environment, the Fed cannot do anything to bring down unemployment. If anything, they only contribute to more uncertainty and thus higher unemployment. So far for one goal of their dual mandate. More on inflation next time.

Moreover, liquidity is abundant and more liquidity is not needed. It helped in 2008 when the financial system was experiencing a lack of liquidity and the Fed had to step in to address this market failure. But now, only a very small amount of businesses find they are credit constraint, and probably the Fed cannot overcome this. They have done whatever they have to do. Now it's time for the Fed to get their hands off of it and let Congress, now matter how divided they are there, do its job.