Using the Treasury TIPS (Treasury Inflation Protected Securities) one can determine inflation expectation simply by subtracting the treasury yield for the same maturity. As an example.
10 Year TIPS currently yields 0.29% (inflation adjusted yield)
10 Year Treasury currently yields 2.66% (non inflation adjusted yield)
The difference of the two is the inflation expectation over 10 years in this example 2.37%
Who cares and what does this have to do with QE3? The Fed has made it very clear a deflationary environment scares the hell out of them. Any threat of deflation and the Fed will flood the market with liquidity in an attempt to cause inflation. Sure there are benefits in their eyes of higher stock prices but to simply think if the SPX hits a certain level QE3 will be enacted is naive group think.
Below is a chart of inflation expectations over the past few years.
Notice the trend going into the announcement of QE2. Clearly inflation expectations across the entire treasury curve were moving below the Fed's target of 1-2%.
QE2 was successful in rising inflation expectations as indicated by the sharp move higher once the program commenced.
Today look where inflation expectations stand, well above the levels of last summer. Should the economy soften further, demand will fall and so will the threat of inflation so QE3 is still quite possible but as of today I would not expect an announcement at Jackson Hole this month other than a reference that if inflation expectations fall that the Fed will begin another program.
