This afternoon brought the latest statement from the Federal Reserve, and the big news is that they’ve decided not to implement any additional quantitative easing (QE) measures for the time being. The 9% stock market rally so far this month has been partly attributed to investors anticipating the possibility that the Fed would unveil a new program of large-scale asset purchases to support the economic recovery, possibly on the order of another $1 trillion or so. We didn’t believe that was very likely at this particular meeting for several reasons, including the proximity to the November elections and still positive economic data. Of course, they left open the possibility that QE might be necessary going forward if the economic recovery falters.
While the QE 2.0 arrow was kept in the quiver, the market did latch onto some new language regarding inflation. Remember, the Fed pursues a dual mandate to maximize economic growth while maintaining price stability. In the past, the price stability part of the equation was usually focused on containing inflation. Now, policy makers are concerned about trying to avoid deflation. They seemed to indicate that inflation is currently running too low (core CPI is less than 1%) for their tastes, with the implication that they may need to take some sort of action in response.
Investors immediately reacted to those comments – stocks, gold, and foreign currencies all surged, while the dollar tanked. However, many times there are knee-jerk reactions to events like these that end up completely reversing in a short period of time. It will be interesting to see how things play out in the coming days – will the market remain buoyed by the inflation comments, or will some degree of disappointment set in due to the lack of additional QE?