Market relief at speculation of moves to aid economy
THE pace of US economic output is slowing, household spending remains constrained by high unemployment, bank lending is still contracting and the economic recovery is likely to be more modest than expected in the near term.
Cue a rally in stocks and US Treasuries. Goodness knows how markets would have reacted had the US Federal Reserve said things were really bad.
The rally, of course, was nothing to do with the ghastly situation outlined by the Fed but the way it signalled its willingness to confront it.
Whilst Ben Bernanke and his colleagues did not actually announce a new round of quantitative easing - the so-called QE II - they have certainly done their best to keep alive speculation that it is imminent.
Confirmation that the Fed is to begin recycling proceeds from maturing mortgage bonds into US Treasuries is not just symbolic. In doing so the Fed has highlighted the size of its balance sheet, something it has not done before.
However, there are potential pitfalls, one of which is that the Fed is likely to buy Treasuries that most closely resemble the duration of those mortgage bonds maturing.
But the US government, anxious to see off potential refinancing problems by extending the maturity profile of its debt, would doubtless prefer it to focus on its longest-dated bonds. The most upbeat message from last night's statement is that the Fed, despite all the deflation talk, plainly doubts that the US is 1990s Japan redux.
The worry is how markets will react to the dawning realisation that, with yields already at rock bottom, another round of QE might not actually achieve much.
Or how they will react when the Fed gets so concerned about the state of the economy that it decides on further monetary loosening.