What comes after QEII?
I think it's an issue for stocks in 2011. Do we get QEIII or does the Fed let the printing presses rest for a while?
I don't think the economy is going to turn around and start creating jobs all of the sudden next year. So the jobless recovery will trudge on and the politicians and central bankers will keep talking about how to get hiring going again. QE will still be a relevant topic when the current Fed program ends.
If the Fed decides that they've printed enough dollars for a while I'd expect the markets to tank - almost like a rate increase. But if they Fed says "sure, we intend to print until employers decide to hire", I think all hell could break loose as confidence in the future value of the dollar is questioned.
My guess is that the Fed will signal that the QE party is over for a while and just let the program expire. It won't be good for stocks, but it's the lesser of two evils.
The other interesting dynamic is how the government goes about cutting the deficit or not. The Republicans have made it clear that we won't be raising taxes on anyone, even dead rich people with huge fortunes to pass on to their heirs. The Democrats have made it clear that we won't be cutting entitlement programs, even by raising the retirement age by two years for those who have yet to be born. For a while we just borrowed the money from China and Japan. Recently we've had the Fed rushing to lend out its freshly printed greenbacks to go with those from Asia. So we haven't really had to address the problem that we love entitlements but hate taxes. When QEII ends we'll probably have to get realistic about this situation or the bond vigilantes will get realistic about it for us.
You sometimes see graphs that show a large percentage of each tax dollar going to pay for interest on the national debt. Well, the rate seems to be around 3% lately and the interest takes up a sizeable portion of the budget. It isn't that unrealistic for rates to go up to more like 10% over the next decade or two, and it could be 100% of the budget. Rising interest rates are no joke.
So one of the biggest questions I have for 2011 is "When QEII ends, does the rate on the 10-year Treasury go up or down?"
We saw what happened with QEII - the rates went UP. If the Fed pulls QE and the rates go up again, then what do we do?
Another risk is that Congress will start messing with the Fed too much and make people nervous about the value of the dollar. Congress likes QEII. Congress is great at spending and not so great at taxing. If they controlled the printing press directly, they could play Zimbabwe with it, and they probably would, and the market knows it. When QE goes away, Congress will have to get more realistic about that lower taxes and increase spending problem, and one of their first reactions will be to whine about the Fed. The Tea Party has an anti-fed streak anyway, and the liberals might just go along with it if the entitlement spending gets threatened. It seems more likely that Congress will attack the Fed than for Republicans to agree to tax increases or for Democrats to agree to cuts in entitlement spending.
I think US govt debt may be one of the biggest stories of 2011.