Ben Bernanke's very public concern for the strength and longevity of the US economic recovery is an unequivocal warning that the Fed is ready to open the quantitative easing tap once again. With the Fed Funds rate effectively at zero, and government bond returns at historic lows the Fed has run out of monetary tools to support the economy, that is, except for quantitative easing.

The $2.3 trillion Fed portfolio contains billions of dollars of soon to mature mortgage bonds and other assets. The funds from these expiring bonds can be kept at the Fed, allowing the portfolio and the money supply to shrink or they can be reinvested in other securities, preventing the currency stock from declining. By the end of next year $200 billion in bonds are projected to reach completion. In the context of at $14 trillion economy and an $8.6 trillion money supply (M2), the substantive effect on the economy and currency circulation of reinvestment would be slight. But it would be a powerful signal to the markets of the Fed's commitment to support the US economy.

The US M2 money supply had been largely stable from November of last year to the end of April, averaging a little over $8.51 trillion per month for that period. Since then it has been steadily rising.

From January through April the money supply averaged a modest 1.45% monthly decline, (January -7.6%; February 9.0%; March -3.3%; April -3.9%). In May the supply rose 12.2%, the largest monthly increase since it vaulted 32.8% in December 2008 at the height of the financial collapse. In June it added 4.5%. These supply increases coincide precisely with the slowing of the American economy and the emergence of doubts about the pace and sustainability of the recovery, not the least at the Fed itself.

The likely trigger for a QE program by the Fed would be a return to rising unemployment. The circle from increasing joblessness to falling home prices and consumer confidence, restricted consumption, economic contraction and the potential financial and economic effects on a still weak economy might well prompt the Fed into action, despite its possible negative effects on the dollar, commodity prices and the funding of the Federal deficit.

Whether the Fed announces another QE program at the FOMC meeting next week probably depends on the July jobs data, to be released this Friday at 8:30 am. But the Fed Chairman has made his intention plain.

One thing to remember, when the Fed announced its last quantitative easing program on March 18th  2009 the dollar lost 3.9% against the euro and 3.2% versus the yen on the day.

Joseph Trevisani

Chief Market Analyst

FX Solutions

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