NEW YORK Investors betting on a rise in stocks, bonds and commodities should prepare for a loud sucking sound in their portfolios next month when the Federal Reserve pulls the plug on its $600 billion stimulus program.
Stocks, bonds, gold and the euro are expected to fall in the three months after the end of the Fed's second massive bond buying operation, also known as quantitative easing, or QE2, a Reuters poll of 64 analysts and fund managers found on Thursday.
Investors and traders approach the end of QE2 with a sense of trepidation, worried that with the Fed no longer supporting the market, investments that have been profitable for the last nine months will plummet and rattle confidence in the shaky economic recovery.
The survey showed investors overwhelmingly thought government bonds would suffer from the Fed's exit, with 40 of 64 respondents saying the end of quantitative easing would drive up yields on U.S. 10-year Treasury bonds.
Although equities and commodities prices have already been declining in anticipation, the end of QE2 will likely leave markets more vulnerable to issues that investors overlooked as long as the Fed was printing money at a record pace.
Concerns about the European debt crisis, the Chinese economic slowdown and the struggling U.S. jobs market, already gnawing away at investor confidence, may now take a big bite out of sentiment across a range of markets.
"The psychological impact of QE2 is more important than the action itself," said Jason Pride, director of investment strategy at Glenmede in Philadelphia, with $19.8 billion under management.
"QE2 is a statement that the Fed will act as a backstop," he added.
Volatility is also poised to grow as declining global liquidity makes investors less willing to take on risk at any price. Out of 63 respondents, 36 said markets will become more volatile when QE2 ends.
The dollar, on the other hand, should gain as the Fed stops lowering its value by printing money. Out of the 64 participants, 38 expect the greenback to strengthen versus the euro, while 14 see no impact.
Still, the exchange rate between the two currencies will mostly depend on broader developments in the euro zone and the United States, both struggling to manage mountains of debt after the global financial crisis.
COMMODITIES, STOCKS TO SUFFER
At least half of the respondents expect oil and gold prices to fall further in the third quarter, hurt by a stronger dollar that will make them more expensive to non-U.S. investors.
Nearly half of participants also expect U.S. and emerging markets stocks to fall, as measured by the Standard & Poor's 500 index and the MSCI Emerging Market stock index.
"Equity indexes, like other tangible assets, were the beneficiaries of QE," said Ray Humphrey, who helps manage $159.6 billion at Hartford Investment Management Co.
"This is illusory, however, as much of the rise in equity and commodity prices can be attributed to measuring the value of these asset classes in a currency that is being devalued."
Despite the expected weakness in financial markets, most analysts were fairly confident the U.S. economy remains on a recovery path that will allow policymakers to reduce the monetary stimulus next month.
The probability of a third round of quantitative easing policies was only 10 percent, according to the median forecast from 59 responses.
The Federal Reserve remains caught between the need for more immediate economic support and the risk of long-term inflation, but analysts say the balance is beginning to shift toward the longer-term issue.
"The economy is slowing but I don't think there is much risk of a double-dip. The Fed will have little urgency there (for a QE3)," said Milton Ezrati, market strategist at Lord Abbett Co in Jersey City, New Jersey.
But David Joy at Boston-based Columbia Management, prefers to leave the door open for QE3.
"If you saw a slowdown over the summer months, especially one that was accompanied by a meaningful slowdown in the money supply, I think QE3 is a viable policy option."
(Additional reporting by Richard Leong, Ellen Freilich, Herbert Lash, Caroline Valetkevitch, Chris Reese; additional polling by the Bangalore Polling Unit; editing by Ross Finley)