Despite all the talk about how the Fed is "out of bullets" and how QE2 failed, traders are still conditioned to view monetary stimulus as being bullish for stocks. Take Tuesday for example: Hurt early by more weak economic data, the stock market recovered on hopes for more action by the central bank.
After rallying 3.7% in the prior three trading days, the Dow was heading higher early Wednesday too as traders revisited a time-tested mantra: "Good news is good, and bad news means Fed intervention," as one money manager put it.
That sentiment was cemented Tuesday when Chicago Fed President Charles Evans, a voting member of the FOMC, told CNBC he "would favor more accommodation" and said the economy would be worse off without QE2.
Separately, minutes of the Fed's Aug. 9 meeting showed FOMC members discussed taking immediate action before settling for "stronger forward guidance as a step in the direction of additional accommodation."
Consensus is building for more policy action at the Fed's September meeting, which is now going to be a two-day affair. Many Fed watchers believe Ben Bernanke is going to use the "extra" day to twist a few arms and limit dissent. FOMC members will also have another month of data, which presumably will support the idea that the economy needs more help.
That, at least, is the view of Ward McCarthy, chief financial economist at Jefferies. As detailed here, McCarthy believes the next batch of economic data is going to be weak, following the direction of consumer confidence if not the magnitude.
McCarthy also expects the Fed to deliver what he's calling "QE2.5" -- an extension of the average duration of the Fed's balance sheet vs. an expansion of its size.
"Priority number one is to get the economy rolling again -- off three cylinders and hopefully closer to six," he says. "Their primary interest is making sure we get the economy going so we can get unemployment down."
Indeed, that was reflected in the comments of Fed president Evans who said a 9.1% unemployment rate is "consistent with recession," while declaring inflation is far from a worry
"Strong accommodation needs to be in place for a substantial period of time," he told CNBC. "If we could sort of make everybody understand that this is going to be in place for a longer period of time, we could knock out some of that restraint that comes about when people talk about premature tightening."
Between renewed hopes for Fed action and speculation President Obama will offer some big policies to aid housing on Sept. 8, the 'risk-on' trade is back in fashion. Like atheists in foxholes, there are few (true) libertarians on Wall Street.