Stocks Lower on Speculation of Early End to QE

After a flat trading session Tuesday, stocks are weaker across the board Wednesday on a growing sense that the Fed could speed up the pace of QE tapering, thereby exiting the program sooner-than-expected and putting itself on a path to raise interest rates.

The Dow is down 97, the S&P 500 is off 7 and the Nasdaq is off 4.

The FOMC has a two-day meeting next week, with a policy decision expected on June 18th. As noted at ZeroHedge earlier, Scotiabank's Guy Haselmanis is speculating that the FOMC may accelerate the monthly pace of QE reductions to $15 billion from the current $10 billion pace. This would mean the FOMC would not have to wait until its September 17th meeting to announce the final leg and QE would then end two months earlier at the end of August rather than the end of October as markets currently expect.

Haselmanis said there are plenty of reasons to justify such a move: global interest rates are near historical lows levels; equity markets are at record high levels; the FTSE All-World index closing at an all-time high yesterday; the decade-low in volatility indices; the 6.3% Unemployment Rate; employment gains averaging 250K over the last two months; GDP forecasts for the remaining three quarters of 2014 fluctuating around 3% following the ‘transitory’ Q1 weather-induced slow down; the current lull (or temporary decline) in Ukrainian and Geo-political tensions; and lastly, the ECB accepting the stimulus baton.

While only speculation at this point, markets are clearly preparing for such a scenario. In fact, Forex markets are already discussing the possibility of an early QE exit and could be pricing it in accordingly. Citi's Head of FX, Steven Englander, said this today:

The languid risk-off that we see in asset markets (weak EM FX, strong JPY, weak S+P futures) is likely to continue into and perhaps beyond tomorrow’s US retail sales data. Investors worry that the Fed will deliver another June surprise. This could take the form of tapering by more than an additional $10bn, highlighting improved economic data, noting firming in core and headline PCE in recent months, linking buoyant asset markets to future policy or signaling a possible earlier hike to policy rates. Right now fed funds futures expect a Fed hike in Sep 2015.

Tomorrow’s retail sales release could add to these fears. Citi expects headline at 0.8%m/m (consensus 0.6%) and core at 0.5% (consensus 0.4%) . Our economists also indicate that weak April data could be revised up. A strong release would play into the fears noted above. We do not expect the Fed to change its dovish tune next week but given the rally in risk assets the last six weeks or so, we will see short-covering and some hedging of long risk positions until the FOMC makes its stance clear.

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