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Kass: Sell Rosh Hashanah

It could be argued that the finite nature of QE1 and QE2 strategies successfully lifted asset prices without lifting inflationary expectations, but to me, the Fed's QE3 strategy is borderline reckless, as the Fed has removed the constraint on inflationary expectations and on U.S. dollar weakness, which could, in the fullness of time, lead to a loss of control of its balance sheet.

I am skeptical that QE3 (i.e., open-ended purchases of mortgage-backed securities) will mollify the modified liquidity trap we are currently in, and I am skeptical that the labor market and/or real economy will feel any benefits from the recent Fed announcement. In fact, I see the unintended consequences of higher inflation and rising intermediate- to longer-term interest rates as, at the very least, diluting what the Fed is trying to accomplish.

While since June 2012, mortgage-backed securities yields are down by about 40 basis points relative to the yield on the 10-year U.S. note, the yield on the 10- year U.S. note is up by over 40 basis points, so mortgage rates are actually slightly higher in the last three months despite the promise (and now actuality) of easing. I am worried that the U.S. housing market, which the Fed is seemingly targeting, may not even benefit from QE3.

Inflation is taxation without legislation; it is not market-valuation-friendly and could, if severe enough, choke off the consumer. The prospects of more easing have already lifted inflationary expectations (measured by the imbedded inflation rate in TIPS) by over 50 basis points since June 2012.

The open-ended nature of QE3 could conceivably reduce the pressure on our leaders to fix our deficit because the cost to finance it is kept artificially low (creating a moral hazard) and owing to the growing perception that Bernanke "has our back." In turn, the U.S. dollar might continue to drop, and competitive devaluation will become a risk, as the Fed will have no credible means of ending QE3.

Even though we have concluded that the benefits of easing are small and the consequences are large, the QE3 announcement was followed by pronouncements by many that fundamentals don't matter anymore, as the world's central bankers are giving an all-clear signal. One commentator even said, "You cannot fight the Fed; just buy everything." Excuse me? And ignore economic statistics and political and geopolitical challenges?

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