No Taper in September

To the surprise of many, the Fed decided not to begin tapering QE3 at its meeting today.  Personally, I expected a modest taper of $10 billion (in other words, it would start purchasing $75 billion worth of Treasuries and mortgage-backed securities each month instead of $85 billion).  What happened?  I think many on the Fed had been concerned about excessive leverage and speculation in the system as evidenced by record-low long-term interest rates, record low interest rates on high-yield bonds, etc.  Once the possibility of tapering began to be discussed, there was an unwinding of risk in financial markets (higher long-term interest rates (including mortgage rates), interest rates on high-yield bonds, etc.).  Since this mission was accomplished, even more than what the Fed had expected, the Fed could turn its focus back to the economy.  As discussed in previous posts, the economy is growing at a modest pace and there is question as to how much the spike in interest rates will affect economic growth in the coming months.  Together with continued low inflation, the Fed felt comfortable delaying tapering until at least its next meeting.

Was this the correct move?  It's debatable (I would have voted to taper a little).  Hopefully it'll provide further stimulus to the housing market and the rest of the economy without reigniting excessive speculation; only time will tell.  Financial markets have responded by increasing stock prices and oil prices by more than 1% (compared to before the announcement) while driving down the yield on the 10-year bond by about 0.2% (as of 3pm on September 18).

What's the Fed's outlook for the economy in the coming years?  Here's a link to its latest forecast.

Some thoughts on the Fed, QE3, and Financial Markets

Let's take a look back at some of the economic news from this week.  First, in response to some turmoil in financial markets, several members of the FOMC tried to clarify the remarks Ben Bernanke made following the Fed's most recent meeting while some commentators complained that Bernanke was not clear and the Fed had a communication problem.  Fed members said what Bernanke meant was that the Fed plans to begin reducing QE3 (tapering) once the economy strengthens further, using a 7% unemployment rate as a guidepost.  Tapering isn't immediate, but would probably begin later this year, assuming Fed forecasts turn out to be correct, and QE3 will completely end next year.  They emphasized that it's data dependent, so if the economy is weaker than expected, QE3 would continue for a longer period of time.  They also emphasized that tapering shouldn't be confused with an increase in the federal funds rate, which is unlikely until 2015.  How does this differ from what Bernanke said (see previous post)?  What he said was basically:

The Fed plans to begin reducing QE3 (tapering) once the economy strengthens further, using a 7% unemployment rate as a guidepost.  Tapering isn't immediate, but would probably begin later this year, assuming Fed forecasts turn out to be correct, and be QE3 would completely end next year.  It's data dependent, so if the economy is weaker than expected, QE3 would continue for a longer period of time.  Tapering shouldn't be confused with an increase in the federal funds rate, which is unlikely until 2015.
 
If you can't tell the difference, that's OK; they just repeated what Bernanke had already said.  From my perspective, it was hard to misinterpret Bernanke (there must have been some hidden signal; saying that rates would rise in 2015 probably meant 2014, ...).  Why didn't the Fed just say tapering would begin in September (or December) and QE3 would end in June 2014?  Because QE3 is designed to strengthen the economy and reduce unemployment.  If it needs to be in place a little longer to achieve the goal, it'll be extended (tapering beginning in 2014 instead of late 2013, etc.).  So making tapering of QE3 dependent on the state of the economy makes perfect sense.  As a reminder, I'm a skeptic of QE3 (see here and here), so I'm not defending the policy.

So why did markets react they way they did to Bernanke's hints in May and his remarks following the most recent Fed meeting?  First, let me point you to a post prior to the Fed's meeting about rising real interest rates.  Since QE3 involves Fed purchases of bonds, some investors thought it would be a good idea to buy the bonds before the Fed did (since demand from the Fed would increase bond prices, it makes sense to buy the bonds first so you can benefit from the price increase).  Also, negative real interest rates caused many investors to seek better returns in riskier assets.  Once the reality sunk in that QE3 wouldn't go on forever and interest rates started to increase, these trades reversed.  As a result, interest rates spiked and asset prices declined, particularly on riskier assets such as emerging markets.  I don't think this represented investors thinking that the Fed going to end QE3 immediately or increase the federal funds rate soon, but instead represented the unwinding of speculation.  There's a lot less speculative excesses in financial markets now compared to a month ago, which is a good thing for the future (makes new bubbles less likely). 

What is the likely impact of the spike in interest rates on the economy?  That will be addressed in a future post.  What's the key takeaway from what's happened in financial markets in recent weeks?  In an era of record low interest rates (near zero on safe assets), many investors took on greater risk than they would normally prefer in order to achieve a higher return.  The reality of QE3 ending at some point in the foreseeable future along with the subsequent increase in real interest rates caused investors to better appreciate the riskiness of their investments, which is a good thing over time (though it may hurt in the short run).

The Fed's Latest Announcement Regarding the Direction of Monetary Policy

As expected, the Fed announced this afternoon that it will continue QE3 without tapering, for now.  In addition, it released its latest forecasts for the economy.  What are the headlines?  During the press conference following the announcement, Ben Bernanke said that, if the Fed forecast turns out to be correct, the Fed will probably begin tapering its purchases of bonds later this year and end QE3 by mid-2014.  Also, a large majority of FOMC participants anticipate the federal funds rate beginning to increase in 2015.  The initial response of the market has been a sharp decline in stocks and a significant increase in interest rates with the ten-year bond rising to 2.33%, the highest since March 2012.

Let's take a closer look at the Fed's view of the economy.  First, it should be noted that the projections are those of each of the 12 district banks, not the Federal Reserve itself (i.e., not the Board of Governors or Ben Bernanke).  The table below show the central tendency of the forecasts, which is the range of forecasts after eliminating the 3 highest and 3 lowest forecasts for each variable. 
 

	2013	2014	2015
Economic growth	2.3 to 2.6%	3 to 3.5%	2.9 to 3.6%
Unemployment rate	7.2 to 7.3%	6.5 to 6.8%	5.8 to 6.2%
inflation	0.8 to 1.2%	1.4 to 2%	1.6 to 2%

note: the forecast for the unemployment rate is for the end of the year

In addition to the forecasts, the Fed noted that it thinks the downside risks to the economy have subsided (less risk of a slowdown).  The forecast for economic growth for all 3 years is somewhat more optimistic than that of most private forecasts, but the other forecasts are in line with other forecasts.  What are the implications for monetary policy?  The Fed has announced thresholds (their word, not mine) for inflation (forecast above 2.5%, 1-2 years in the future; it relies on a forecast of inflation since it takes time for monetary policy to impact inflation) and the unemployment rate (6.5%) for when they are likely to consider increasing the federal funds rate.  Today, Ben Bernanke suggested that QE3 would likely end as the unemployment rate reached 7%.  Given that the Fed expects the unemployment rate to reach 7% in Spring/Summer 2014, QE3 will likely end around that time (if their forecast is correct).  Since it will preceded by a gradual reduction in bond purchases, the tapering will likely begin in late 2013.  Ben Bernanke emphasized that if the data shows a slower economy (including a higher than expected unemployment rate), QE3 could be extended further into 2014 (and thus tapering may not start until sometime in 2014).

What are the key takeaways from the latest news from the Fed?  It is more confident about the strength of the economy, but still thinks it requires stimulus.  In addition, it provided some clarification as to when it would begin to taper and eventually end QE3, though the exact timing is dependent on the data.  As of now, it expects that tapering will begin later this year with QE3 coming to an end by this time next year.

The Fed Minutes and QE3

Those who follow financial news are aware that the release of the minutes of the Fed January meeting contributed to a decline in the stock market yesterday (Feb 20).  Basically, the minutes revealed that there was significant debate over the costs and benefits of QE3 and raised questions as to how much longer the Fed will engage in quantitative easing (click here for an earlier post describing QE3; earlier posts have also addressed the arguments for and against QE3).  In a speech earlier this month, Jeremy Stein, one of the newest members of the Board of Governors gave a speech, "Overheating in Credit Markets: Origins, Measurement, and Policy Responses," which provided useful insight into the thinking of some members of the Fed as well as ways to assess whether credit markets are functioning properly (i.e., if credit is too easy, whether credit is being misallocated - too much credit going to higher-risk borrowers, etc.).  Stein's speech is insightful, but one needs a solid understanding of finance and economics to follow it.  Here are some highlights.  Junk bond (bonds issued by high-risk corporations) issuance is at a record high as shown below:

The above chart shows that both banks (blue) and non-bank institutions (red) issued record amounts of leveraged loans at the end of 2012 and high-yield corporate bond issuance also hit a record high (top chart).   Meanwhile, credit spreads on high-yield (junk) bonds have declined significantly (see below), but are not out of line with historical averages (note: this is the difference between the interest rate on an average high-yield bond and a comparable US Treasury bond and measures the perceived risk of holding high-yield bonds):

Though the credit spread is not out of line with its historical average, it must be noted that interest rates on high-yield bonds are at record lows.  How does that work?  The credit spread of 400 basis points (i.e., 4%) indicates that interest rates on high-yield bonds are 4 percentage points above US Treasuries.  But interest rates on US Treasuries are still near record lows reached earlier in 2012.  When one adds 4% to a near record-low Treasury interest rate, the result is a record low junk bond rate.

Stein's conclusion is that there are preliminary indications of credit markets may be overheated, but not necessarily posing a significant problem yet (some other indicators are mixed).  He does raise the concern that if the trends continue, there may be a credit bubble that could have a harmful impact on the economy.

OK, what's going on?  QE1 (Fall 2008) was designed to avoid a financial collapse/depression.  QE2 (2010) was smaller and designed out of fear of possible deflation (market-based estimates of future inflation were declining significantly).  QE3 (Fall 2012) is intended to be an economic stimulus, particularly to reduce long-term unemployment which, if left unchecked, may lead to some of the currently unemployed to become unemployable, resulting in a "permanent" increase in unemployment.  Pushing interest rates lower should help interest-sensitive parts of the economy (for example, housing and autos) thus restoring stronger economic growth.  Given that housing and autos are now the strongest sectors of the economy, it seems to be working.  So what's the problem?

As we saw in the mid-2000s, if credit is too cheap, riskier borrowers may obtain credit to which they shouldn't have access, setting the stage for problems down the road as risky borrowers default, etc.  In the short run, it's helpful for more companies and individuals to get credit, but risky lending is harmful over time (recall the housing bubble and its aftermath).  Doesn't the Fed realize this?  Of course.  Those supporting continued quantitative easing perceive that lending is too risk-averse and thus should become a little riskier.  Also, the benefits of short-run stimulus offset the possible problems down the road (and it could be reversed in time to avoid some of the future problems).  Stein's speech points out that credit may already be too easy (or soon will be) and that the potential costs are rising.  In addition, reversing policy to avoid the future problems is easier said than done,

What's the key takeaway?  Conducting monetary policy is very difficult, particularly in the aftermath of a financial crisis.  Though the Fed may want to implement loose policy (policy that makes credit easier to obtain) in order to offset lending policies that are perceived to be too risk averse and to provide an overall boost to the economy, it must consider the underlying details.  Policy that results in too many risky borrowers obtaining credit can result in worse problems down the road.

Declining Risk Premium: QE3?

The risk premium on Baa corporate bonds has declined significantly in recent weeks and now stands at 2.72% (as of Thursday Oct 18), the lowest since the summer of 2011.  Here's a chart of its recent behavior (chart is weekly data since Aug 24 (the week before Bernanke's speech at Jackson Hole; doesn't include the decline to 2.72% so far this week):



When was the last time it declined this much?



What was taking place during this period (Fall 2010 to early 2011)?  QE2.  Thus, there's evidence that QE2 helped the Baa risk premium to fall by about 0.75%.  So far, QE3 has resulted in a decline in the risk premium of 0.5%.  How long did the decline from QE2 last?  It remained between 2.5% and 2.6% for most of the next 3 months before beginning to rise again in June 2011 (as QE2 came to an end).

Update:  Here's the rest of the story - a chart that shows the risk premium from the start of QE2 until the debt limit controversy of August 2011 (note: the risk premium was about 2.8% at the end of July 2011 before spiking in August 2011).



The Fed must be happy to see evidence of easing of credit so far due in part to QE3.  Given the open endedness of QE3, will the risk premium continue to decline and remain relatively low (at least compared to recent times)?  We'll have to wait and see.

QE3 after 2 weeks

It's been just over 2 weeks since the Fed announced that it intends to implement a third round of quantitative easing (QE3).  Since I included some of the initial impacts in an argument against QE3, I thought it would be appropriate to provide an update.

What's happened to expected inflation?  Prior to Bernanke's speech in Jackson Hole, Wyoming, during which he indicated the likelihood of QE3, break-even inflation according to the 5-year TIPS was 1.92%.  The day after QE3 was announced, it stood at 2.39% (the highest since summer 2008).  Two weeks later, it's back down to 2.11%.  Thus, as of now, market participants aren't worried about a significant increase in inflation resulting from QE3.

Another gauge of financial conditions that I like to look at is the risk premium on Baa corporate bonds, a measure of the perceived risk of relatively safe companies.  Prior to Bernanke's speech, it stood at 3.2%.  The day before the announcement, it was 3.18%; now it's 3.05% (down from a summer 2012 high of 3.46%).  The last time it was consistently below 3% was in early August 2011 (prior to the debt limit debacle).  What's normal?  Risk premiums of 2% or less were common before the financial crisis (it rose past 6% during the worst part of the crisis).  Is the recent decline due to QE3?  There are probably several factors, but the Fed would be happy to reduce the cost of credit for businesses (and consumers), helping to provide support for a stronger recovery.

What about oil prices?  Prior to Benanke's speech, the price of a barrel of West Texas Oil was $94.60; it rose to almost $100 per barrel the day after QE3 was announced.  Currently, it's about $92 per barrel.



Of course it's too early to draw conclusions, but so far it's hard to find evidence of a noticeable change in inflation or inflationary expectations as a result of QE3.

The Case Against QE3

I made a case in favor of QE3, so now it's time to make the case against QE3.  As with any policy, there are costs as well as benefits.  The arguments in favor of QE3 emphasize the potential long-term damage that could result from a permanent increase in unemployment.  However, there is reason to doubt about how much QE3 will reduce unemployment.  Interest rates in general and mortgage rates in particular are at historic lows.  How much lower will they go as a result of QE3?  We'll see.  But rates will have to decline significantly to have a noticeable impact on the housing market.  A decline of 0.25% or less is unlikely to have a significant impact.  The already low interest rates have helped corporations and many mortgage holders to refinance, helping to strengthen their balance sheets.  Another small decline in mortgage rates is unlikely to have much of an impact.

In addition, the Fed has tried to limit its purchases of securities to short-term Treasuries to avoid introducing distortions to financial markets.  In other words, buying mortgage-backed securities will artificially reduce mortgage rates until the Fed withdraws the stimulus sometime in the future (2015?).  When that occurs, there's likely to be a higher than normal increase in interest rates (including mortgage rates) as rates rise from artificially low levels (in addition to increasing due to economic strenghening).  At that point, lenders will have a considerable amount of mortgages with low interest rates locked in while they'll need to start paying higher rates on deposits.  In addition, people with low mortgage rates will be somewhat reluctant to move, knowing that they'll have to pay a higher interest rate when buying a new house (of course many people will have to move for a new job, etc., but this will reduce the amount of "voluntary" moves).

Though lower interest rates increases the demand for loans, they may discourage lenders from making loans if it reduces the spread (lenders earn profits based on the difference between what they earn on loans and what they pay for funds).  Smaller spreads may encourage lenders to focus on prime customers.

What about inflation?  Prior to Ben Bernake's speech at the Jackson Hole conference on August 31, break-even inflation using 5-year TIPS was 1.92%.  On Wednesday, September 12, it was 2.12% (Friday evening update: it rose to 2.39% on Friday; the highest since the summer of 2008; the break-even inflation rate using 10-year TIPS is 2.64%, the highest since 2006).  Thus, in anticipation of QE3, expected inflation has risen somewhat (highest since May 2011).  CPI inflation is running at 1.7% over the last 12 months while core CPI inflation is 1.9%, as close as you can get to the Fed's target of 2%.  So unlike prior to QE1 and QE2, neither inflation nor break-even inflation is considerably below the 2% target (click here for details).

Is QE3 responsible for high oil prices?  Not yet.  Here's a chart showing the behavior of oil prices since June 2012:



As can be seen, most of the recent increase occurred prior to Bernanke's speech in Jackson Hole.  Prior to the speech, oil sold for about $94.60 per barrel; as of Friday morning, September 14, it's $99.50 per barrel.  Some of the increase can be attributed to turmoil in the Middle East while some is due to increased speculation due in part to QE3.

Clearly, there's a lot to be considered, but I'll address one last topic - the Fed's exit strategy.  This was a hot topic about a year ago (the Fed even began to test methods that could be used to remove reserves in the future).  Given the extraordinary size of the Fed's balance sheet, making it even large increases the complexity of any exit strategy.  In other words, removing $3 trillion of excess reserves is more difficult than removing $2 trillion of excess reserves.  Removal of excess liquidity needs to be done with care - not too soon (hurting the recovery) but not too late (increasing inflation).  As mentioned earlier, distortions in financial markets resulting in artificially low rates will disappear when the Fed implements its exit strategy.  The more the distortion, the harder the adjustment back to normal conditions (and the Fed is hoping for significant distortion in order for the policy to be effective).

Add it up and I think the costs exceed the benefits.  If financial markets locked up again due to a European implosion or if fears of deflation started to take hold, additional QE would be justified.  However, given sluggish growth (which is still growth), inflation close to its target, and the limited impact, I would not have voted for QE3.

The Case for QE3

Let me begin by repeating that I would have voted against QE3.  That said, Ben Bernanke is a very good economist with honorable intentions, so there's some good reasons for it.  Here's the case for QE3.

The key aspect of QE3 involve the intent to purchase $40 billion worth of mortgage-backed securities as long as the unemployment rate remains high and even as the economy begins to strengthen.  That tells us a few points behind the rationale.  Of course the weakness of the recovery is reason for further stimulus, but the design of QE3 suggests a significant concern about the long-run behavior of the labor market.  Ben Bernanke and others on the Fed fear hysteresis.  What's that?  It occurs when a significant number of the unemployed remain out of work for an extended period of time, rendering them unemployable.  Thus, short-term unemployment resulting from a recession results in long-term unemployment which becomes a permanent fixture of the economy.  That could mean they leave the labor force and don't come back (witness the significant decline in the labor force paritcipation rate in recent years) or they remain in the labor force and become structurally unemployed (want a job but aren't qualified for the jobs that are available).  As a resuslt, the "normal" unemployment rate (what economists call the natural rate or NAIRU) rises.  A consensus seems to be developing that the "normal" unemployment rate has risen from just below 5% to 6% (still some diagreement with some thinking it could be as high as 7% while others think it is somewhat lower; hard to be sure given it's still changing).  What's the big deal about an increase of about one percentage point?  One percent translates to about 1.5 million people (given the current labor force of about 155 milion).  So the human cost is quite high.  In addition, with 1.5 million fewer workers employed during normal times, the economy won't be able to produce as much, reducing potential GDP.  For now, let's assume that these permanently unemployed workers that remain in the labor force are half as productive as the average worker.  Taking GDP divided by the total number of people employed gives the average output per worker ($109,000).  Divide that in half to estimate output per worker becoming permanently unemploed.  Multiply that by 1.5 million and it's over $80 billion per year (not including those that permanently drop out of the labor force).  In order to reduce the likelihood of this permanent increase in unemployment and loss of output, the Fed thinks it's worth doing it all can to reduce unemployment and thus reduce the likelihood of hysteresis.

Why mortgage-backed securities instead of US Treasuries?  One reason for the very weak recovery is that residential investment is not rebounding like in previous recoveries.  Following the 1973-75 and 1982 recessions, residential investment contributed an average of about one percentage point to economic growth for the first two years of recovery.  What about this time?  In 2010 and 2011, residential investment's contribution was slightly negative.  Also, some of the highest unemployment rates are in occupations related to construction, so targeting mortgages instead of interest rates in general can have a more significant effect on unemployment.  In addition, when people buy houses, they also tend to also buy furniture as well as other purchases, so some may say that spurring the housing market could help with sales of furniture and other durable household equipment (the government's term, not mine).  In the recoveries of the mid-1970s and early-1980s, this category contrubuted about 0.2% to economic growth for the first two years compared to about 0.1% this time (not much of a difference).

One other change was the statement that the Fed would continue to engage in QE3 even after signs of economic strengthening.  Previously, it was thought that the Fed would back off when positive economic data started to take hold.  Michael Woodford, an economist with the St. Louis Fed, presented a paper at a central bank meeting in Jackson Hole critical of this policy.  He made the case that this sends the signal that the Fed was implying that it was going to provide stimulus because the economy was quite weak, which may reduce consumer and business confidence.  By stating that it would continue to provide stimulus even after there are signs of economic strengthening, it may be able to provide stimulus without damaging confidence, resulting in a more powerful effect.

Summing up, inflatio is under control (below 2%), unemployment remains stubbornly high with signs of a permanent increase in the normal rate of unemployment, resulting in singificant human costs and permanent loss of output.  Extraordinary efforts to reduce unemployment can thus provide long-term benefits to the economy.

QE3!

The Fed has just announced a new round of quantitative easing (QE3).  Specifically, the Fed announced that it will start buying $40 billion worth of mortgage-backed securities per month (conditional on the performance of the labor market) and continue Operation Twist for the remainder of the year (sell short-term securities, buy long-term securities, $45b/month).  Also, it indicated that it anticipates maintaining low interest rates through mid-2015.  The goal is to reduce long-term interest rates, particularly mortgage rates, with the hope of increasing borrowing and spending in general and providing support to the housing market in particular.

How did financial markets react?  I'm writing this at 12:45pm (15 minutes after the announcement).  The initial reaction is a 0.5% increase in stock prices as well as some increase in gold & silver.  However, oil and gas prices have not risen.  What about long-term interest rates?  Yields on ten-year Treasury bonds have risen significantly, from 1.72% prior to the announcement to 1.82% as of 12:50pm.  Why would the yield on Treasuries increase?  Some possible reasons include the fact that the Fed is going to purchases mortgage-backed securities instead of Treasuries and concerns about higher inflation.

Was it the right move?  Argument in favor of it includes the weakness of the economic recovery (economic growth below 2% in the first half of 2012 & unemployment above 8% accompanied by subpar job growth).  Also, inflation is running below 2% (the Fed's target).  The hope is that lower long-term interest rates will spur growth providing some support to the recovery.  That said, Ben Bernanke and other members of the Fed know and hae stated that there are limits to any benefits.

Arguments against include that this will probably have a very limited effect on economic growth.  Interest rates are already near historic lows.  Also, though overall inflation is below 2%, core inflation is close to 2%.  Energy prices are already rebounding from recent declines, so overall inflation will rise in the coming months (beginning with tomorrow's inflation report).  Also, as mentioned in a previous post, expected inflation as measured in the market for TIPS (treasury-inflation-protected securities) is not that low (break-even inflation over the next five years is about 2.1% and rising somewhat in recent weeks compared to significant declines prior to QE1 and QE2).  Also, this will complicate the Fed's exit strategy.

What's the take away?  Though the Fed has discussed the limits to another round of QE3, it chose to implement a new round of quantitative easing.  It did make it contingent on the performance of the economy, so if the economy strengthens, it could choose to stop QE3 after a few months.  More likely, it will continue well into 2013.  Also, it can't be accused of trying to finance the budget deficit since it chose to purchases mortgage-backed securities instead of government bonds.  What's my initial take?  I would have voted no.  I don't anticipate significant benefits and I think it introduces more distortions to financial markets that may be hard to unwind.  Do I think it will lead to rapid inflation?  Not anytime soon.  I wouldn't be surprised if there are more posts on this topics in the coming days.

Key Indicator of Prior Quantitative Easings

There continues to be talk as to whether the Fed will implement another round of quantitative easing in the coming months (QE3).  What indicator should one watch to determine if QE3 is on the way?  Here's a chart of the break-even inflation rate on five-year treasuries:

Break-even inflation is the difference between the yield on the five-year US Treasury bond and the five-year TIPS (Treasury inflation protected security).  The yield on TIPS represent the interest earned apart from inflation, to which enough interest to cover inflation is added to one's return.  The difference between traditional Treasuries and TIPS is the amount of inflation necessary to result in an equal yield between the two securities (break-even inflation).  It gets a little complicated, but expected inflation is less than break-even inflation since an inflation risk premium is implicitly part of break-even inflation.

Back to the main point.  one of the Fed's main goals is to keep inflation at about 2% (that's it's inflation target).  You'll notice two periods during which break-even inflation declined significantly.  Of course the first time was at the depths of the financial crisis in late 2008, when break-even inflation collapsed to -2%.  The collapse in inflationary expectations was one reason the Fed engaged in the first round of quantitative easing.  The second instance was not as dramatic, but took place in the summer of 2010.  After reaching a short-term peak of about 2% earlier in 2010 (2.16% in January, 2.01% on April 30), break-even inflation experienced a significant decline to 1.22% in late August.  What stopped the decline?  Break-even inflation bottomed out and began to rise when Ben Bernanke laid the groundwork for QE2 at a speech in Jackson Hole, Wyoming.  Thus, both QE1 and QE2 were preceded by market perceptions of deflation or that inflation would be exceedingly low.  Does that exist today?  As the chart shows, break-even inflation is relatively stable (about 1.9%), indicating that QE3 is unlikely at this time according to this indicator.