QE, Mortgaged Back Securities and Treasuries

Note that they are buying MBS, not treasuries (other than a bit of the long-dated via Twist); if they buy many more treasuries, the Fed will own such a large number of them that large parts of the treasury market will have no international liquidity left and will stop functioning properly. 

Now given that in addition to that being a disaster on its own, at a basic level treasuries are the foundation of the financial system. Huge numbers of transactions involve treasuries as collateral. No treasury equates to no collateral; similarly, treasury illiquidity equates to weak collateral. They know this fact, hence the announcement of open ended but no finite dollar amount pledged in. This is actually very different than if they had announced a $800bn QE3, locking themselves into that amount. It is not quite possible that they can actually buy that many without imploding the market. They have a bit of leeway with MBS but there is also a finite market there. 

In other words, rather than seeing this as infinite QE, it can be regarded as indeed the announcement that they are going all in and throwing in the kitchen sink, yet basically they are trying to keep people from realising they actually do not have a kitchen sink. It is more of psychology/jaw-boning than anything,

They could not deal with the consequences of saying they would not do it anymore. This is the real QE3: "We are telling people we are doing this to infinity in the hopes that people believe it and act accordingly and thus the problem goes away, and we thus do not actually have to do this to infinity, before people figure out that we actually cannot do this to infinity in the first place."

Note: 
*QE3 is about using MBS (a much more finite market than Treasuries) to inject liquidity, and QE3 is not about using Treasuries to inject liquidity. There is no kitchen sink to throw. 
*For financial markets and effects to economies, LDMR negative returns will set in (refer to previous write-up: http://donovan-ang.blogspot.sg/2012/09/spx-correlation-with-qe1-qe2-ot-and-qe3.html).

Law of Diminishing Marginal Returns: 

Negative Returns Are Going to Be Priced In

SPX Correlation with QE1, QE2, OT and QE3

The Law of Diminishing Marginal Returns at Work

The following shows the SPX correlation with QE1, QE2, OT and lets us have a rough guide of how QE3 would be like. 

In Economics Theory, there is always the Law of Diminishing Marginal Returns (LDMR). When the maximum marginal returns has reached, the returns start to get less and can potentially turn into negative returns with each increment of a specific X.

The SPX is currently behaving with all the characteristics of the LDMR. 

When too much money floods the market, it is initially good, as it can depress the interest rates and stimulate production. Incomes increase while inflation levels are subdued in a recessionary economic environment; however, the effect becomes less and less with each flooding operation (Q.E) as can be seen from the SPX chart (Cost of Production C.O.P eating up growth); flooding operation will reach a point where negative returns set in, which in this case, the now over-excessive liquidity-stimulated inflation (on oil, raw materials for production, necessities) will maliciously eat into growth, corrode GDP, evaporate employment, and spark another depressing vicious cycle even though interest rate can still theoretically remain low. The negatives will  flex over the positives which is the point LDMR sets in. 

Before the QE3 was implemented, the media and majority of funds worldside had already anticipated it. Likely, QE3 has been absorbed by the market in the several weeks leading to the QE3 announcement, and the market may need to start pricing in the negative returns now. This will go with market selling/distributions as oil spikes up and while majority of market herd (retailers/small fishes/investors/everyone with experience in QE1 and QE2 expecting market to continue to rally) are buying into it. Classical conditioning at work is often what kills majority of market participants because they are already brained-washed based on the previous two or three histories they had. 

The relatively good or steady performance in financial markets should, at best, tide until the US presidential election. At worst, selling may start before one even anticipates it. During this time to presidential election, it is highly likely that Big Hands and Insiders are engaging in distributions and secret sellings/off-loadings to majority of market participants/investors, who are still classical conditioned based on their experiences with QE1 and QE2. They may find that their experience with QE3 or QEx differs from what they would expect as market likes to do the opposite.

Related:
http://donovan-ang.blogspot.sg/2012/09/qe-mortgaged-back-securities-and.html