The effect of quantitative easing is to extend and defer the consequences of reckless speculation, provided that low-risk liquidity is viewed as an inferior asset. Quantitative easing doesn’t eliminate the consequences of speculation and overvaluation, and in our judgment only promises to make the fallout more severe. But we should generally expect the worst consequences to emerge at those points when speculative, overvalued, overbought, overbullish conditions are joined by increased risk-aversion, as evidenced by widening credit spreads or subtle deterioration in the uniformity of market internals. Those shifts are clearly evident here, and our immediate concerns could hardly be more acute.
An improvement in the behavior of credit spreads and market internals would significantly reduce the immediacy of our downside concerns, though it would not ease our longer-term concerns about valuation. Presently, market internals and credit spreads imply a measurable shift toward investor risk aversion – one that is likely, for now, to leave further monetary accommodation relatively ineffective in provoking fresh speculation aside from short-lived announcement effects – not that renewed easing would be a good idea in any event. This outlook will change only as valuations, credit spreads, and market internals shift
