NEW YORK (TheStreet) -- I've been baffled by the chorus of media calls and the apparent market anticipation of QE3 by the Federal Open Market Committee meeting ending Wednesday. I understand the power of wishful thinking, or at least so I think. But this one is beyond me.
The U.S. economy has been remarkably consistent over the last two years, namely being stuck in limbo land. Every good number is instantaneously met with an equal and opposite bad number.
In other words, we're fast becoming Japan as I had predicted two years ago on SeekingAlpha, though possibly with a slightly higher stagnation baseline due to various sociopolitical differences. And for those who think the Fed will or should come to the rescue so long as the economy is not busting at the seams, the hope is not supported by the history of Fed actions.
As I wrote on SeekingAlpha in June, history clearly shows the five-year market-expected inflation, in the form of difference between five-year Constant Maturity Treasury rate and five-year Treasury Inflation-Protected Securities rate, is a critical barometer the Fed watches closely.If the inflation expectation drops below 1.5%, the Fed gets nervous and starts seriously debating about full-scale QE, with the action significantly delayed after hitting 1.5% at both times. If it drops near 1.5%, the Fed may do some version of QE Lite, such as Twist. As of July 30, inflation expectation stands at 1.78%, pretty close to the sweet spot of 2% as far as Fed is concerned. The following chart summarizes these points: On top of this, oil (represented by the United States Oil Fund (USO)) is still at elevated levels and agricultural commodities (represented by PowerShares Agricultural commodities ETF (DBA)) are very high and expected to remain high for the foreseeable future. It will take some time for high corn prices to propagate throughout the food supply, but propagate they will since corn is the most important feedstock for virtually all diary and meat products. The commodity inflation is not as dire as in late 2010 to early 2011, in the aftermath of QE2. But right now we only have Twist2. I think it's clear at least some FOMC members have learned the lesson from post-QE2 commodity inflation scare (2.5% inflation expectation is the trigger for Fed easing, or at least close to it). Fed needs a very good reason to do a full-scale QE. At this point it has none.
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