Update

Friday is going to be a very important day: Q2 GDP estimates at 8:30am, and the Bernank speaking from Jackson Hole at 10am.

Gold off $100 to 1760.  If yesterday's move was in fact the market betting on a "Fed Miracle" ie QE,3 why would gold have such a dramatic sell off these past two days?  A third round of quantitative easing is about the only catalyst for gold to sustain its parabolic move to 1900.  Also, the dollar index (DXY) is slightly positive today and the Euro continues to fail @ 1.4450.  If the market truly expects QE3, the dollar should be getting crushed.

Despite lower growth expectations and continued weakness in employment and housing, the Fed cannot pull out the bazooka - not yet at least - because of rising inflationary pressures.  The money supply, a leading indicator, continues to grow - M1 increased 5.5% m/m and 20.8% YoY, and the YoY increase in the last two weeks is the highest in history (The Bonddad Blog).  So what options does the Bernank have?  The most likely scenario is not additional printing but a shift in the Fed's balance sheet from short term bonds to longer term maturities - Operation Twist Redux I mentioned a few days ago.  This will have the intended effect of lowering long term interest rates which will support the housing market.

But will implementing OT Redux have this effect?  It is important to remember what happened when the Fed initially committed to quantitative easing - rates actually shot up!  Investors sold treasuries and reallocated into risker assets (stocks), a counterintuitive move but one that makes sense given the inflationary pressure of QE.  So if the Fed commits to buying longer dates maturities (30 yr), I'm expecting the same effects - the yield curve will steepen, and money will flow from bonds into equities.  This may be why we have seen yields rise in the past couple days as the 30 yr has fallen off 4% and the oversold financial sector has bounced 5% (financials will ultimately benefit from a steepening yield curve).  A caveat: this analysis is dependent on a GDP number which is inline with estimates.  We are expecting 1.1% real annualized growth, and a miss coming in just about flat (or even negative!) would certainly send treasuries higher and spur more talk of a double dip recession.

My game plan on a inline GDP number: TBT and C