Chairman Ben has shown us the assumptions the FOMC is using to set monetary policy and Bernanke has also got his way with publishing a 2% inflation target.  In his press conference he was keen to stress that the Fed will look to stimulate the economy further provided inflation stays under control as unemployment is not falling fast enough towards 6%.  Hence QE3 is likely very soon, before the Presidential election hots up later this year.

The first interest rate rise is likely to be when unemployment falls near to 6% (providing inflation stays under control).  This may be earlier than late-2014 if QE3 proves successful in stimulating the economy to grow faster.  However buying a few hundred billion of mortgage bonds will keep mortgage rates low for new buyers (currently 3.88% for 30-year mortgages) but QE3 won’t help existing homeowners with negative equity to re-mortgage.

In his press conference Bernanke said the Fed has estimated US homeowners are currently underwater to the tune of $700 billion.  Hence the real stimulus to the economy will come from allowing existing homeowners who have perfect payment records to re-mortgage despite their loan being worth more than their house.  However it will take legislation to allow this to happen and that seems unlikely this side of the November 2012 Presidential election.

However the Fed’s policy of keeping rates at zero whilst allowing the economy to accelerate over the next 3 years (in order to create jobs for the vast numbers of unemployed people – both official and involuntary) will provide a sweet spot for corporates.  They will be making hay in an expanding economy with no threat of the Fed jacking up rates to spoil the party.  With this backdrop and given that equities are not expensive, we can expect the US stockmarkets to rally to new all-time highs (S&P 1,576) - just not necessarily in a straight line.  The markets will climb the wall of worry surrounding Europe as I believe the ECB has done enough with its 3-year LTROs to halt the panic in Europe’s sovereign debt markets.