The Fed has been dumping roughly $4 billion of thin-air money into the US markets each trading day since November 2010. The markets, all of them, are higher than they would be without this money. $4 billion per trading day is an enormous amount of money. It's gigantic by historical standards. As soon as the QE program ends, (June 30th) the markets will have to subsist on a lot less money and liquidity, and the result is almost perfectly predictable.
The Fed dumps cash on the risk markets by purchasing treasuries from primary dealers (banks and security brokerages) who then pour that money into risk trades: stocks and commodities.
In the past, Treasury buyers have been 50% foreigners, and 40% public institutions and individual savers, with the Fed purchasing the remaining 10%.
Recently, however, the Fed has accounted for 70% of the buying while foreign entities comprise about 30% of the purchases. Of those foreign entities, about 20 percent appear to be off-shore shell banks set up by the Fed to purchase treasuries.
So the big question after June 30th, 2011 is who will fill in the hole left by Fed when they exit QE2?
Certainly they can continue to purchase treasuries through shell banks and by other "non-traditional" procedures. However, Fed watchers have become quite sophisticated in their methods of detection and surveillance. It will be difficult for them to continue their purchases while claiming to have ended quantitative easing.
Clearly, that they have announced the end of QE2 along with a termination date, will in itself cast a pall over all risk trades. Count on it. Markets are sentiment driven. Even if the Fed seeks to mitigate the effect of their termination date it will be very difficult to sway sentiment without a public announcement of the continuation of Quantitative Easing.
The markets will demand it.
Will the political will be there to support it?
Not until the politicians see the effect of a dead risk trade in markets that subsist on risk.
At some point, when all the fiscal conservatives talking a big fiscal game see their own retirement accounts, as large as they may be, shrink by 50-80 percent, they'll be the ones leading the charge for QE3.
Count on it.
Until then... duck and cover.