Sunday, October 17, 2010

Bernanke's Fed wants some inflation to fight off deflation

On Friday, Chairman Ben Bernanke said the Federal Reserve "is prepared to take new action to boost the economy, because inflation has been too low of late and unemployment is poised to come down too slowly". He also noted, "there are clearly many challenges in communicating and conducting monetary policy in a low-inflation environment, including the uncertainties associated with the use of nonconventional policy tools".

MY TAKE: For many weeks, the market has been expecting the Fed to pursue another round of quantitative easing (printing more money). The expected outcome from such action should be a decline in long-term interest rates, an increased appetite for riskier assets such as equities and a weaker dollar that could help to increase exports. However, complicating the landscape are issues such as 1) many nations want to devalue their currency to address economic issues, 2) commercial banks may continue to increase their capital reserves to deal with non-performing loan portfolios instead of increasing lending and 3) terms such as "uncertainties" and "nonconventional" suggest that the Fed may be in a reactive mode as it navigates uncharted economic territory.

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