Liquidity and QE2

With liquidity abound, QE2 has been a positive factor in igniting the current stock market rally.  As the Federal Reserve purchases bonds, the cash is being reinvested into the stock market via hedge funds, mutual funds, pension plans, and large institutions. 

However, QE2 has also precipitated both a rise in interest rates as well as a spike in commodity speculation (most commodities are priced in dollars), likely hurting many more than a stock rally helps. Also, as raw material input costs rise, companies must raise prices or cut costs to preserve margins as it is difficult to pass on these costs to consumers.  

So one of two things will likely happen:

1. businesses try to increase prices, they are not able to, and see their profit margins cut
2. businesses do raise prices, people buy less because of wage constraints, and revenue gets hit.

In both instances, companies will likely need to reduce costs to improve profit margins.  While this isn't an issue at the moment, it will be important to monitor moving forward as most commodities have seen prices rise dramatically in the past six months.  And it takes about 6 months or so for these price increases to work into the system.

See charts below: