Be prepared for Quantitative Easing Round 2 (QE2) and/or other misguided Fed policy decisions because Bernanke Says Fed Ready to Take Action.

Treasuries rose, pushing two-year yields to the fourth record low in five days, as Federal Reserve Chairman Ben S. Bernanke said the economic outlook is "unusually uncertain" and policy makers are prepared "to take further policy actions as needed."

Ten-year note yields touched a three-week low as Bernanke said central bankers are ready to act to aid growth even as they prepare to eventually raise interest rates from almost zero and shrink a record balance sheet.

"An unusual outlook may call for unusual measures, and that means the Fed may take more action as needed, which would lead to lower rates," said Suvrat Prakash, an interest-rate strategist in New York at BNP Paribas, one of the 18 primary dealers that trade with the central bank.

The Fed chief didn't elaborate on steps the Fed might take as he affirmed the Fed's policy of keeping rates low for an "extended period." Economic data over the past month that were weaker than analysts projected have prompted investor speculation the Fed may increase monetary stimulus in a bid to keep the economy growing and reduce a jobless rate from close to a 26-year high.

"Bernanke acknowledged that things weren't very strong economically and left action on the table without going into details, and that's sending investors from stocks into bonds," said James Combias, New York-based head of Treasury trading at primary dealer Mizuho Financial Group Inc.

Monetary Policy Report to the Congress July 2010

Inquiring minds are slogging through the 56 page Monetary Policy Report to the Congress July 2010. Here are a few key snips.

Summary of Economic Projections

Participants generally made modest downward revisions to their projections for real GDP growth for the years 2010 to 2012, as well as modest upward revisions to their projections for the unemployment rate for the same period.

Participants also revised down a little their projections for inflation over the forecast period. Several participants noted that these revisions were largely the result of the incoming economic data and the anticipated effects of developments abroad on U.S. financial markets and the economy. Overall, participants continued to expect the pace of the economic recovery to be held back by a number of factors, including household and business uncertainty, persistent weakness in real estate markets, only gradual improvement in labor market conditions, waning fiscal stimulus, and slow easing of credit conditions in the banking sector.

Participants generally anticipated that, in light of the severity of the economic downturn, it would take some time for the economy to converge fully to its longer-run path as characterized by sustainable rates of output growth, unemployment, and inflation consistent with participants' interpretation of the Federal Reserve's dual objectives; most expected the convergence process to take no more than fi ve to six years. About one-half of the participants now judged the risks to the growth outlook to be tilted to the downside, while most continued to see balanced risks surrounding their inflation projections.

Participants generally continued to judge the uncertainty surrounding their projections for both economic activity and inflation to be unusually high relative to historical norms.

The Outlook

Participants' projections for real GDP growth in 2010 had a central tendency of 3.0 to 3.5 percent, slightly lower than in April. Participants noted that the economic recovery was proceeding. Consumer spending was increasing, supported by rising disposable income as labor markets gradually improved.

Participants anticipated that labor market conditions would improve slowly over the next several years. The central tendency of their projections for the average unemployment rate in the fourth quarter of 2010 was 9.2 to 9.5 percent. Consistent with their expectations of a gradual economic recovery, participants generally anticipated that the unemployment rate would decline to 7.1 to 7.5 percent by the end of 2012, remaining well above their assessments of its longer-run sustainable rate.

Although a few participants were concerned about a possible decrease in the sustainable level of employment resulting from ongoing structural adjustments in product and labor markets, participants' longer-term unemployment projections had a central tendency of 5.0 to 5.3 percent, the same as in April.

Forecast Uncertainty

The economic projections provided by the members of the Board of Governors and the presidents of the Federal Reserve Banks inform discussions of monetary policy among policymakers and can aid public understanding of the basis for policy actions. Considerable uncertainty attends these projections, however. The economic and statistical models and relationships used to help produce economic forecasts are necessarily imperfect descriptions of the real world. And the future path of the economy can be affected by myriad unforeseen developments and events. Thus, in setting the stance of monetary policy, participants consider not only what appears to be the most likely economic outcome as embodied in their projections, but also the range of alternative possibilities, the likelihood of their occurring, and the potential costs to the economy should they occur.

Fed Enormously Optimistic

In my opinion the Fed is enormously and erroneously overoptimistic about its assessment of the economy, especially unemployment. The odds we get back to 5% unemployment anytime soon are close to zero. And unless the participation rate collapses, we are far more likely to see higher highs, possibly above 12% before we start to see the rate drop.

Be Prepared for "Unusual Actions"

The Fed seems to be sensing it may be wrong in its optimistic assessment judging from Bernanke's "Unusually Uncertain" statements.

In my opinion, risks are not just "skewed" to the downside, they are enormously skewed to the downside.

By the way, history suggests that when Bernanke implies an unusual outlook may call for unusual measures, he means it. However, there is absolutely no reason to believe it will be any more effective this time than last.

Moreover, one thing banks have going for them is a steep yield curve, forcing that down (or yields collapsing on their own accord) is not going to force banks to lend, nor consumers to borrow.

Bernanke Has Met His Match

Hyperinflationists will be coming out of the woodwork on the Fed's statements today. However, I calmly note that Bernanke has met his match: consumer attitudes.

We have reached a Consumption Inflection Point - No One Wants Credit and consumer spending plans have plunged. There is nothing Bernanke can do to "fix" that.

Besides, there is nothing to "fix" anyway. Boomers headed towards retirement better be saving more and spending less. The same applies to kids out of college without a job.

Finally, I note that Bernanke thinks consumer spending is on the rise. It's not. Bernanke needs to get out in the real world and see what's happening. He can start by reading Rockefeller Institute Confirms Rising Retail Sales a Mirage.