Sell the news?

The first week in November will indeed be momentous and full of wild cards. We will see the US mid-term elections, followed by the FOMC meeting in which QE2 is expected to be announced. Right now, the market consensus for both events are both equity bullish. However, it's important to examine the implications of these events to see if they are indeed bullish.


Is deadlock really market bullish?
The Republicans are expected to take back the House, but the Democrats are expected to narrowly retain its Senate majority. The Street consensus has been "deadlocks are bullish for the markets", but is it really in this case?

FT Alphaville highlighted the analysis from the strategy team at RBS. Highlights include (my comments in parentheses):

• Political deadlock means deadlock on fiscal policy. Monetary policy will have to do the heavy lifting (we are back to that QE2 again...)
• It also means regulatory uncertainty. (Do we really want "little" issues like the foreclosure crisis to linger?)

High market expectations for QE2
As for the upcoming FOMC meeting, I wrote about it before here and pointed out the risks that QE2 could spell the end of Bretton Woods 2. The market is pricing in about $1 trillion in QE2, while signals from the Fed is that it will be substantially less, with room for "flexibility" to raise the program if necessary. This, to me, seems to be a recipe for disappointment.
 
Fed watcher Tim Duy echoed some of the concerns of the RBS team about fiscal policy when he wrote last week [emphasis added]:

The Obama Administration is poised to turn its attention to deficit reduction, seemingly oblivious to the historical errors of Japanese fiscal policy, not to mention the US experience in the Great Depression. For better or worse, that leaves monetary policy to bear the burden. But the Federal Reserve is signaling they are poised to deliver far less than necessary to meet expectations, expectations that already were likely overly optimistic. 

And does the issue of "flexibility" only go one way?

To be sure, Fed policymakers will argue that they are trying to preserve flexibility. Why is it that "flexibility" means the ability to scale up? Why can't "flexibility" mean the ability to scale down? Seriously, it is not as if the Fed is in any danger of hitting either of the objectives in the dual mandate anytime soon. And does Bernanke really believe that it will be any easier to offer a credible commitment to scale up once Dallas Federal Reserve Chairman Richard Fisher is a voting member of the FOMC?

Are the markets getting leery?
While the markets seem to have very high expectations for QE2, early market action is indicating that the tide is turning. The US Dollar, which had been falling on expectations of QE2, seems to be stabilizing:

Interest rates are backing up:

Gold prices have also pulled back:

Bespoke's analysis of the stock market during mid-term elections indicated that equities have an upward bias for election day and for the week. Given the high expectations and the risks to these events, perhaps it's time to "sell the news"?