David Morris

STOCK markets got plenty of attention last month following strong rallies in the major indices. But September also saw impressive gains for precious metals and the euro, although the latter was more a function of dollar weakness. Although there are plenty of good reasons to avoid the euro, the single currency has surged against the dollar, thanks to the growing expectation of further QE at the November Fed meeting.

The markets are pricing in these shortened odds and all financial instruments now include some premium (or discount) accounting for the chance of a flood of fresh dollars into the system. Speculation has edged away from the timing towards the size of QE2. Will it be a $1 trillion-plus shock and awe exercise, or a series of smaller stimuli with no upper limit?

There is a counter-argument which says that QE2 (especially as early as November) is far from certain. To start with, Minneapolis president Narayana Kocherlakota, Atlanta Fed president Dennis Lockhart, the Philly Fed’s Charles Plosser and Richard Fisher of the Dallas Fed have recently all seemed less than convinced. Yet none is currently a voting member on the FOMC. Fed chairman Ben Bernanke is known to support further intervention and ultimately his view will prevail.

In late August, Bernanke said the FOMC would be ready “to provide further monetary accommodation...especially if the outlook were to deteriorate significantly”. The S&P has rallied over 9 per cent since then, and it is this statement which does much to explain how equities manage to rally in the face of disappointing economic data. This Friday sees the release of the unemployment rate and non-farm payrolls, the last to be published ahead of the FOMC’s November meeting. It is a crucial piece of data since a bad number will convince investors that Bernanke has the excuse he needs to launch QE2.