Forex Investment and Currency Trading

For the Fed, core inflation heading to zero is a green light for as much quantitative easing as it wants, at least while the economy is still weak. Eventually the Fed may have to face an issue that Japan has struggled with in recent years – what to do with the inflation target? Unlike other countries, the Fed does not have a formal target but it has made it clear in recent years that it wants core inflation to be in the 1-2% range. Indeed this has become a standard view for most central banks – much above 2% and the evidence suggests that GDP growth suffers, while below 1% there is a risk of deflation and the interest rate tool looses effectiveness. So, if the Fed sticks to its inflation target (or indicated “comfort zone”), it can in theory convince the markets both that it is determined to get the economy going and that it will avoid inflation taking off to high levels. But there may be a conflict; if the bond market believes that the Fed really will achieve (say) 1.5% inflation over the long term, then longer maturity bond yields will not be too low. Indeed today‟s 30-year yield below 3% is vulnerable. Yet, part of the prescription for getting the economy going is precisely to get long term yields low. Japan struggled with this dilemma, without resolving it, and for the most part never convinced the markets it would achieve a significant positive inflation rate. The JGB 10-year yield has stayed below 2% since 1999, while the 30-year has mostly been below 2.5%. The Fed will need to consider this issue later in 2009 as inflation recedes.