Bernanke Sees Upbeat Second Half, But Doesn't Rule Out QE3 If Needed

Fed Chairman Ben Bernanke spoke to a congressional committee this morning, offering a more optimistic assessment of the economy than his last public comment, just two weeks ago. At least that's how it sounded, but when I look at my notes from the last time, the forecasts are the same for 2011, and down a bit for 2012. (However, with a median forecast of about 3.5 per cent, next year will be a lot better than this year's 2.5 per cent.)

The markets focused on another part of his testimony, however, where he made the point that if the forecasts were wrong and things really went sour, no, the Fed would not stand idly by, and yes, they would come in with further extreme measures. The markets liked that part, and the Dow was up 1.25 percent during the speech, although most of that move had been made earlier in the session.

It's hard to specify, but the general tone of Mr. Bernanke's testimony seemed more positive than the last one. Fed governors are looking for an increasing pace to the economy in the second half of 2011, and growth of 3.3 percent to 3.7 percent for 2012, "notably better" in the Chairman's words. The factors that have driven up inflation -- higher oil and car prices -- should relent. The household debt picture is improving, and that should bolster consumer confidence and spending (and borrowing too).

Ultra-low interest rates will be left in place for the time being.

On the crucial topic of quantitative easing, he said that the Fed's steps so far, completed in June, had been effective. He emphasized that what matters is the quantity and mix of what the Fed had bought, rather than the pace of purchases. That suggests that they believe that holding the zillions of bonds is what's important, rather than having to step in to buy more.

He also gave a road map on withdrawing the big easing: first they will stop reinvesting principal of the QE bonds, then be sure to tell us all about it; raise their interest rate targets; and as a last step start selling the QE portfolio, but not without telling us first.

I spoke to Mike Pond, astute bond market analyst at Barclays Capital, and he pointed out that in the last press conference, Mr. Bernanke had given the impression that the Fed might not jump in if the economy were to weaken further -- thus the selloff last time. Today there was more reassurance that if growth does fall off, the Fed would step in. A subtle but important difference when the economy is at an inflection point.

But we've got a long way to go -- first, to see better growth in the second half, and then boost that to over three percent next year. That, in my view, is still a long ways off.