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Quantitative easing is working




The steepness of the long end of the Treasury yield curve reached another all-time high today of 126 bps. 10-yr Treasury yields have fallen to their lows for the year, but investors in longer maturities are balking—the steepening of the curve is coming mainly from rising yields on 30-yr Treasury bonds, which are up 20 bps since the end of August. That's a sign that the Fed's quantitative easing program is working.

The Fed can pin the 10-yr Treasury yield at artificially low levels, but easy money can't make an economy grow, except to the extent that the prospect of inflation causes people to invest money they would rather just keep in cash. Shoveling money into the economy mostly results in higher prices, and there is growing evidence that this is occurring.


Against a basket of major currencies, the dollar is down 12% from its June highs, and down 6.5% from its late August level, when the Fed first started to float its QE2 program. Measured against a broad basket of currencies and adjusted for inflation, the dollar is once again at its all-time low level by my estimation (above chart). A weaker dollar, of course, means that prices outside the U.S. are rising. Pinning interest rates at an artificially low level is akin to supplying dollars that no one wants, and so we see that the dollar's value is declining.


Gold is up $25/oz. today, reaching another all-time high and also confirming that the world is awash in dollars. Most commodity prices are rising as well, and oil today is up to $83/bbl.

If there is anything good about these signs of reflation, it's this: rising prices throw very cold water on the notion that the U.S. economy is at risk of deflation. And if you can dismiss the risk of deflation, then the future brightens considerably, and risk-aversion makes much less sense. Investors who are parking cash in zero-interest accounts are forced to reevaluate their convictions and concerns. The calculus increasingly favors taking on some risk, and this is one of the things the Fed is hoping for. As a result, we're getting a modest boost to growth, and increasing signs that inflation may perk up in the future.

The next shoe to drop will be the realization that an improving economy with rising prices means that more quantitative easing is not really necessary. This may short-circuit the Fed's widely telegraphed plan to launch QE2 a month from now, but that would hardly be bad news.

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