Quick Note on Bernanke Press Conference

The market did not seem to respond much to the FOMC statement or the revised forecasts. It has responded to Bernanke's answer to a question about QE. Bernanke said that the Fed is prepared to do more with its balance sheet. The dollar was sold, stocks and bonds firmed.

Yet the market is getting ahead of itself. Bernanke did not break now ground. QE is not off the table, but it is not needed now. In effect Bernanke is saying if more was needed the Fed would provide more stimulus. The fact that the Fed hasn't means that it is not presently seen as needed.

Moreover, the Fed's new forecasts suggest the odds are against needing to deploy its balance sheet further. Specifically, the Fed raised its 2012 GDP forecast (2.4%-2.9% from 2.2%-2.7%), though its revised down 2013 and 2014 growth forecasts slightly. It also revised up 2012 PCE inflation to 19.%-2.0% vs 1.4%-1.8% previously and the core was revised up to 1.8%-2.0% from 1.5%-1.8%.

Our argument is two-fold. First, we see the bar to QE3 as relatively high. A deterioration in economic activity to threaten a recession or require significant downward revision of the Fed's baseline forecasts, or a renewed threat of deflation would be required. The former is more likely than the latter. Second, if QE3 is deemed necessary, the window of opportunity seems to be Q3, when Operation Twist is completed and a better handle the state of the economy will be clearer after the weather and seasonal adjustment distortions fade.

We expect that the deterioration of the situation in Europe, both from an economic and political perspective to be the main driver of risk appetites in general and the dollar in particular.