Deflation dismissed by bond measure amid QE3 anticipation

QE History

The expiration of tax cuts started by President George W. Bush and spending reductions to take effect at the start of 2013 would pull $607 billion from the economy, according to the Congressional Budget Office. If Congress doesn’t act, those events would “pose a significant threat to the recovery,” Bernanke told lawmakers in testimony on June 7.

The Fed’s QE program started with a November 2008 commitment to buy $500 billion of mortgage securities and $100 billion of debentures of Fannie Mae and Freddie Mac. Policy makers raised the purchase targets in March 2009 to $1.25 trillion of mortgage bonds, $200 billion of agency debt and added $300 billion of Treasuries. In November 2010, the Fed announced it would acquire $600 billion of Treasuries.

‘Huge Problem’

The programs created about $2.3 trillion dollars, sparking criticism by Chinese Premier Wen Jiabao, who said in March 2011 that QE2 boosted prices for commodities traded in the U.S. currency. Representative Stephen Fincher, a Republican from Tennessee, said this month during Bernanke’s testimony to Congress that “there is so much money out there” that “inflation is going to be a huge problem.”

Crude oil reached $114.83 a barrel in May 2011, from $70.76 in August 2010. It was at $90.01 today. Rotterdam-based Unilever, the world’s second-biggest consumer-goods maker, sees commodity cost inflation in 2012 to be “slightly higher” than a mid-single-digit increase, unchanged from its forecast in April, Chief Financial Officer Jean-Marc Huet said on a July 26 conference call with reporters.

Bernanke has studied policy errors in the Great Depression and during Japan’s rolling recessions of the 1990s. He said in 2000 that the Bank of Japan should pursue faster inflation to curb the risk of deflation, adding earlier this year that the Fed’s stimulus programs have averted that fate in the U.S.

‘Very Critical’

“The very critical difference between the Japanese situation 15 years ago and the U.S. situation today is that Japan was in deflation,” he said in response to a question at a press conference after policy makers met April 25, the last time he addressed the issue. “We are not in deflation, we have an inflation rate that’s close to our objective.”

Treasury Inflation-Protected Securities, which offer investors a lower annual rate of interest than Treasuries in exchange for an increase in the face value of the debt equal to the rise of the consumer price index, have returned 1.19 percent this month and 5.42 percent for the year. That compares with returns of 0.69 percent in June and 2.36 percent in 2012 for U.S. debt that isn’t linked to price measures, Bank of America Merrill Lynch indexes show.

The five-year, five-year forward breakeven rate, which the Fed uses to help set policy, has ranged this year from 2.37 percent on March 5 to 2.78 percent on March 19. The 0.39 percentage point drop from its high this year contrasts with the 1.59 percentage point plunge to 2.02 percent between October and November 2008, and the 0.98 percentage point decline to 2.18 percent between April and August 2010.

A further decline “is probably what the Fed will need to see before they pull the trigger on further easing,” Robert Robis, head of fixed-income macro strategies in Atlanta at ING Investment Management, which manages about $160 billion, said in a July 25 telephone interview.

Bloomberg News

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