Bernanke, et al., stood pat, much to my great surprise given the macro data they had in hand, and the stock and commodity markets reacted badly. Very badly. The rout I had been expecting has finally arrived, albeit about a month later than I originally thought back in March.
What now?
First, let’s revisit the views I laid out on May 12th in Positioning For The Coming Rout:
My Predictions and Conclusions
I am still convinced that a cessation of quantitative easing (QE) will result in a rather substantial rout that will see commodities, stocks, and then bonds take serious hits from their current values. As before, my advice is to have a substantial cash position and to protect any paper assets that cannot be sold using puts, inverse funds, or other insurance strategies.
I would expect that any approach of the prior lows in the stock market, down -40% to -50% from here, is a near certainty for another intervention. Will the Fed let things go that far? Maybe not, and here’s why.
At first in this sort of a downdraft, we’d expect the usual flight to safety: The dollar will go up, and so will Treasuries. But pretty soon that will taper off (no more money to be sloshed around) and then the federal government, due to falling tax receipts, will have to begin borrowing more and more from a market with less and less available liquidity.
This is when the pain begins to move to the bond market. In the scheme of things, the Fed desires a rising stock market but needs a stable bond market, by which I mean truly stable, not just with rising interest rates.
At this juncture, given the state of the housing market (still sinking) and the massive outstanding and new borrowing needs of the federal and state governments (especially in a time of economic strife), rising interest rates would be exceptionally unwelcome. There’s also the risk that once interest rates start rising they may become self-reinforcing to the upside, a dynamic that would certainly sink the ship of state if it ever got going.
If that sounds unlikely, please consider that just such a dynamic was last seen in the US in the late 1970’s and early 1980’s and it took short-term rates of 21% to finally burn itself out.
by frobn 
