Morning Brief Monday August 27, 2012

Good Morning. This weekend I spent some time studying inflation expectations also known as break even points. By simply taking Treasury TIPS which are inflation adjusted (real yields) and subtracting Treasury nominal yields (not inflation adjusted) you get inflation expectations. And it is pretty clear why the Fed will not launch QE3 in September.In June there was a case but today, there is clearly not.

The Fed has two mandates, managing inflation and maximizing labor. If you go back to the launch of QE1 and all subsequent discussions, the Fed always mentions the threat of deflation.They live in fear of a Japanese style deflationary spiral that once in place is near impossible to control. Imagine if you believe prices today will be lower tomorrow. You will not buy today. In other words demand falls and the economy falters.

So the Fed has fought deflation with the famed “printing press.” The chart below shows just why the Fed launched QE2 in the summer of 2010.

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