QE3 prospects set to keep Wall Street volatile

Friday’s jobs report that showed hiring in the US unexpectedly ground to a halt in August is increasing speculation the US Federal Reserve will move to stimulate the economy. But will it help stocks?

Fed action—if it happens — is no longer viewed as the elixir for the stock market it once was. Wall Street tumbled over 2% on Friday as investors fretted more about the economic outlook rather than looking ahead to another round of Fed bond buying.

This week, the question of whether the Fed will step up to the plate with another round of quantitative easing will take centre stage with a highly anticipated speech from President Barack Obama. That could make for another volatile week.

This time last year, anticipation of a second round of quantitative easing, or QE2, sparked an almost uninterrupted rally that lifted the S&P 500 around 30% from August to May.

What a difference a year makes. Confidence in policy makers is sapping away as the economy languishes, the US grapples with the loss of its top-notch credit rating, and the European Union seems to be coming undone at the seams.

Wall Street sees an 80% chance the Federal Reserve will intervene in the bond market to lower long-term interest rates, according to a Reuters poll on Friday.

But Friday’s action in the stock market signaled that equity investors do not see that prospect as silver bullet for their woes.

The broad-based S&P 500 index fell 2.5% on the day.

“This downdraft is based on sentiment and that has to be turned around,” said Brian Battle, vice president of trading at Performance Trust Capital Partners in Chicago. “I think we’re in for a longer trend of either malaise or just a down channel.”

That means traders and investors who were hoping for a return to normalcy after extreme volatility in August may have to wait a little longer.

Obama is due to address a joint session of Congress on Thursday to lay out plans to create jobs, boost economic growth and lower the deficit.

He faces an uphill struggle when it comes to reassuring investors, who fault the lack of consensus in Washington. Heading into an election year, the disharmony is not likely to get better any time soon.

Non-farm payrolls were unchanged last month, the Labour Department said, and figures for previous months were also revised down to show employers created a combined 58,000 fewer jobs than had been thought in June and July.

The US Treasury market rallied after the data as Goldman Sachs and other US primary dealers — big Wall Street firms that do business directly with the Fed — said they expect the US central bank to start buying longer-dated bonds after its September 20-21 meeting.

Seasoned traders say that August’s extreme volatility was one of the most trying periods in living memory, outstripping the 2008-2009 meltdown and the 1987 stock market crash on Black Monday.

“I’ve been doing this for 20 years and it’s never been more exhausting,” said the chief executive of a New York-based proprietary trading firm, who said many of his traders closed out their positions in August, reducing the firm’s inventories to just 15% to 20% of what they could be.

At least some of that volatility looks set to spill over into September until there is more clarity over the economy and what the Fed is likely to do at its September 20-21 meeting.

But some fund managers who take a more long-term view are using pullbacks to cut back positions that have done less well while increasing positions in their preferred stocks.

Many fund managers are still convinced the US economy will avoid a recession and stocks will rally into the year end.

One of them, Mark Luschini, chief investment strategist at Janney Montgomery Scott in Philadelphia, does not expect the Fed to act this month. He is not expecting a recession, but admits he has become more defensive.