Forget QE3; It's Time for a New WPA

The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.

By Marc Chandler

NEW YORK (BBH FX Strategy) -- With the U.S. economy stalling in the first half of the year and poor survey data, it is hardly surprising that Federal Reserve Chairman Ben Bernanke's Jackson Hole speech on Friday is being awaited anxiously for fresh signals about how the central bank will respond.

Yet, unlike a year ago, the risk of deflation has all but disappeared. The core consumer price index is just below 2%, and core personal consumption expenditures in the second quarter stood at 2.1% (compared with 0.8% in the third quarter of 2010).

Not only is the Fed's preferred (but not sole) inflation gauge elevated, the $600 billion of Treasuries the Fed just finished purchasing and continues to hold appear to have done very little in real economic terms or in rekindling the animal spirits of risk-taking.

Federal Reserve Chairman Ben Bernanke

Interest rates are considerably lower than a year ago. With the U.S. two-year yield within the federal funds target, the five-year yield less than 1% and the 10-year yield slightly more than 2%, how much lower can yields go?

And will a marginal decline in Treasury yields have much impact ? Will a marginal increase in the Fed's balance sheet have much impact?

It is difficult to know what the market is really expecting from Bernanke at the end of the week. Many banks seem to be playing up the odds of a third round of quantitative easing (QE3) being signaled, but they seem to have a vested interest.

There are a number of other options that Fed officials have cited. These include cutting the interest rate on excess reserves (though no one is really talking about a negative rate or a penalty for holding excess reserves), extending the maturities of the Treasuries the Fed holds and including the size of its balance sheet in guidance about rates remaining low for an extended period of time. At times, the idea of a formal inflation target or a interest rate target for yields further out on the curve have also been suggested.

While Bernanke will want to show that the Fed still has options at its disposal, with various trade-offs associated, perhaps he may want to also underscore the limitations of monetary policy.