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Busch: The Fed Inflation Path Taken

In a fascinating WSJ interview, Charles Evans, president of the Federal Reserve of Chicago, provided further support for a massive, unprecedented resumption of quantitative easing by the U.S. Federal Reserve.

"In the last several months I've stared at our unemployment forecast and come to the conclusion that it's just not coming down nearly as quickly as it should...This is a far grimmer forecast than we ought to have.....As result, he said, he favors "much more [monetary] accommodation than we've put in place."

He goes on to suggest that the Fed should push rates down to get inflation higher and to tolerate inflation above it's target of 2% for some time to make up for lost ground.

"That is a potentially useful policy tool at this point and I definitely think we should study it more," Mr. Evans said in the article.

When questioned about commodity prices and gold, he had this response:

"I don’t put a lot of weight on those indicators. Gold moves up and moves down. Commodity prices are often driven by stronger demand around the world and with emerging markets doing better at this point in the cycle that is part of it. Does it worry me about inflationary expectations? I just don’t see that at the moment. When I talk to people in the business community there is not a lot of pricing power."

United States Federal Reserve
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United States Federal Reserve

The markets were not so sanguine about the Fed's new tact on quantitative easing.

From NY Fed's Dudley’s speech last week, the US dollar index has fallen almost 3%, gold has rallied 4% and the CRB has almost 3%. What's more intriguing is that the 2yr break even inflation rate has soared over 50% from .5782 to .8762.

Clearly, the markets are following the Fed's lead by purchasing those instruments that provide safety from a potential increase in inflation.

While these movements reflect the early market adjustments, they portend a troubling direction for future central bank policy. Should they continue, they will likely eliminate much of the 50-75 basis points of Dudley anticipated gain from buying $500 bln worth of new assets by the Fed. Worse, they could resurrect a theory that the Federal Reserve and the US government are embarking upon an inflation based strategy to alleviate the US debt burden.

While this last theory may never come to be, the Fed is treading upon a mine-laden path that has never been tip-toed through in this country.


Andrew B. BuschDirector, Global Currency and Public Policy Strategist at BMO Capital Markets, a recognized expert on the world financial markets and how these markets are impacted by political events, and a frequent CNBC contributor. You can comment on his piece and reach him hereand you can follow him on Twitter at http://twitter.com/abusch.