Fed stops short of QE 3

On Friday Ben Bernanke gave a speech after the Fed’s annual retreat in Jackson Hole. Bernanke has so far refused to consider a third round of quantitative easing. Markets have reacted well to Mr Bernanke’s statement in which he hinted that the Fed still has tools that could be used to stimulate the economy.

Quantitative Easing is the process where the Federal Reserve prints additional money and uses it to purchase government and corporate bonds. The aim of this is to inject liquidity in the markets by reducing long term interest rates. However, the downside of this is that it can lead to more inflation. With US consumer prices rising, it has become more difficult for the Fed to expand the QE program.

Ben Bernanke has said that the Fed will extend its next meeting by 1 day to discuss policy tools to be used in the event that the economy does need to be stimulated more. Bernanke has also called on governments in the US and Europe to use fiscal policy to further stimulate the economy and generate jobs.

Bernanke’s comments have been met with optimism as many investors feel it signals that the Fed does not foresee an imminent recession in the US economy.

Treasury yields are also indicating that the US will avoid recession. The difference in yield between 10-year and 30-year treasury bonds has risen to 1.35%. The twenty year average is just 0.49%. The US has never entered a recession with the difference in yields between 10 and 30 years at such a high level.

The current sentiment in the market is that the Fed will announce further QE in September if US economic indicators continue to under-perform.