Busch: The Easy QE2 Trade is Over

Overnight, the US dollar has had a rallyon what I'd call the "We-can-print-money-too!" theory of central bank easing.

We had ECB head Claude Trichet refute Bundesbank head Axel Weber's assertion that the ECB should stop buying bonds. Also, we had two groups (E&Y, CEBR) state that the UK economy will be flat in Q1 2011 and that former policy maker David Blanchflower said, "We (UK) are desperately in danger of a double dip and the last thing you do in a recession is make things worse. The BOE unfortunately looks like the only 'plan B' the government has, but quantitative easing just doesn't act fast enough." The CEBR says the Bank of England will expand stimulus plan by 100 billion pounds.

As readers of my posts know, I've been stating for some timethat the markets will be disappointed by whatever the Federal Reserve does on November 3rd. Initially, the markets reacted strongly to October 1st NY Fed Dudley's speech on quantitative easing and the $500 billion size suggested for 50-75 basis points. Over the two weeks, the bond market rallied with the US Treasury 10 year yield dropping from 2.75% to 2.35%, the Euro rallied against the US dollar from 1.3550 to 1.4150 and the S&P 500 rallied 3.75%. Chicago Federal Reserve Charlie Evans stated on Saturdaythat the US was in a liquidity trap and advocated the Dudley program.

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However, the bond markets are indicating that they are circumspect over this new program.

After seeing a low yield of 2.33% on October 8th, the yield has risen to a high last week of 2.59%.

The spreads to TIPS for both US Treasury 2 year and 10 year spiked as talk of inflation targeting has surfaced and is making bond holders search for safety.

Subsequently, the S&P has stalled around 1,180 over the same time frame. Finally, the US dollar has recovered some of its losses as well.

Where do we go from here?

First, we'll see how the spate of US earnings goes over the next two weeks. If they are weaker than expected, the pullback will be stronger than expected. Next, we'll have data on the US housing data this week that will likely raise some fears over continued price drops and we'll see lots of stories on the foreclosure problems. This will keep the bond markets from taking yields above 2.60%. Lastly, the US dollar will be buffeted by the G20 finance ministers in Seoulat the end of the week as they meet to hammer out some type of agreement on currency policy. Already, the South Korean central bank head said he hopes that the G20 yield an agreement on foreign exchange policy.

The main point: the easy trading is over until after the 11/3 FOMC meeting.

Andrew B. BuschDirector, Global Currency and Public Policy Strategist at BMO Capital Markets, a recognized expert on the world financial markets and how these markets are impacted by political events, and a frequent CNBC contributor. You can comment on his piece and reach him hereand you can follow him on Twitter at http://twitter.com/abusch.