A Look at a Half Full Glass

Anticipation of QEII in the US remains among the most potent forces in the capital markets. Bernanke's pre-weekend speech and two dovish speeches since--Evans and Rosengren (both voting members of the FOMC).

The case the Fed has built for the public is based on inflation being too low and clearly officials are concerned about the contraction in bank credit too.

Yet there are beginning to be signs that these forces may be ebbing, perhaps in part because of the Fed's signalling effect. Although it may have been lost in the shuffle, a more balanced view would note that the trimmed mean CPI calculation of the Dallas Fed has risen for three consecutive months. Bank credit appears to have stopped contracted. Money supply, measured by M2 has accelerated recently. The St. Louis Fed's money multiplier has has edged up.

Retail sales in the US has picked up after a soft patch earlier in the summer. The Aug-Sept increase was 1.3% vs 0.2% in the June-July period. The National Retail Federation forecasts the strongest holiday sales in the US in four years.

This is not to deny the worrisome challenges the US faces. However, the risk of a double dip in the economy appears to have ebbed in recent months and some of the financial variables also seem to have improved on the margins of late.

With QEII so heavily discounted, largely as a result of the Fed's own guidance, it is as if the Fed has a free pass: If they execute QEII, and the preliminary signs noted here deepen and broaded, they will take (be given credit) for the recovery. If they execute QEII and conditions worsen, they can argue they did what they could. The biggest risk is doing nothing and conditions get worse. Policy makers want to minimize what they perceive to be biggest regret.