US equities, and "risk assets" generally, remain unusually sensitive to Federal Reserve liquidity operations – a relationship established after the Fed embarked on "QE1" in late 2008.

Stock markets began to fall in late April, 8-9 weeks after a peak in the US monetary base (i.e. currency in circulation plus banks' reserves at the Fed), while the rally starting in early July similarly followed a trough in the base 8-9 weeks before in early May – see chart.

After an initially strong recovery, however, the monetary base drifted lower again during June and July, creating a "negative divergence" with a further rally in stocks. Equities buckled last week, after the Fed disappointed hopes of an immediate move to "QE2", involving an expansion of its securities portfolio financed by further monetary base creation. (Instead, it plans to stabilise its portfolio by reinvesting maturing principal in Treasuries.)

With the monetary base moving sideways recently, equities may similiarly remain within the range spanned by the July low and last week's high until the next Fed meeting scheduled for 21 September.

Aside from embracing "QE2", the Fed could boost the monetary base by asking the Treasury to suspend the "supplementary financing programme" (SFP), under which it has effectively sterilised $200 billion of the Fed's "QE1" by issuing additional Treasury bills. The Fed used the SFP to drain liquidity this spring and may prefer this less-public method of providing support to markets and the economy, should "double-dip" worries intensify.