Stocks have staged a modest rally on Mr. Bernanke's testimony on two factors: 1) he has again opened the door to QE3, saying the Fed is "prepared to respond" if the economy weakens, and 2) again reiterating that the factors slowing growth are "transitory," i.e. that gasoline, food, and the Japan quake effects will mitigate in the second half of the year.
Mr. Bernanke has set a very high bar for QE3: "more persistent" weakness in growth and reemerging deflationary risks.
Reemerging deflationary risks? The opposite is happening--we're getting inflation, but Mr. Bernanke is insisting it will moderate in the second half of the year...specifically that commodity prices will stabilize, and that he believes there a "substantial slack" in capacity will continues, which will make it hard for workers to get higher wages and for firms to raise prices.
In other words, the economic recovery will remain tepid.
What makes all this rather circular is that every time traders believe QE3 may be a possibility, they drive up commodity prices, which makes the possibility of QE3...less likely.
One problem: Mr. Fisher from the Dallas Fed implied he would not go along with QE3, calling QE2 "of doubtful efficacy."
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