With most of the recent data displaying growing signs of an economic slowdown around the globe and the stock market experiencing a frightening plunge of 2,000 Dow points in the last 12 days alone, traders are expecting the Fed to mount its white horse and ride to the rescue this afternoon at 2:15 pm eastern time.
However, unlike last year at this time, the Fed’s options are more limited. First and foremost, the rate of inflation has moved from negative to within range of the Fed’s targeted levels. Thus, the bottom line is that the rationale used by Mr. Bernanke last year to justify QE2 (inflation was too low and the employment rate was a problem) is simply not available this time around. In short, while the “full employment” half of the Fed’s dual mandate remains a tough issue, the “stable prices” part is being called into question.
Although the Fed Chairman is on record as saying that the increase in core inflation is likely to be transitory (Bernanke talked about the rise in vehicle prices having been affected by the earthquake in Japan), the FOMC board has a dramatically different makeup now than it did a year ago. As such, Bernanke would likely face stiff opposition if he proposed another round of QE at this stage of the game.
Part of the reason for the opposition to more bond buying is that one of the “unintended consequences” was the dramatic rise in food and energy prices. While this did go toward increasing the rate inflation (one of the stated goals of QE2), it also hurt many consumers across the U.S. and in other countries. In addition, the intended boost to asset prices was initially successful in the stock market but never really materialized in the housing market. And given that the stock market has now give up nearly all of the QE2 gain, one can also now question the overall effectiveness of the bond purchase program.
However, it is a safe bet that Mr. Bernanke has not backed off his quest to keep the U.S. out of a deflationary cycle. And given that the economy “feels” like it is about ready to fall off a cliff after a massive dive in the stock market, Bernanke is likely to do something today to try and calm the restless natives.
So, what can the FOMC do today? Here’s our short list of options available:
- While not likely, the Fed could announce another round of bond buying
- The FOMC could announce that it will maintain the current size of their balance sheet “for an extended period.” This would tell the markets that the Fed won’t be selling anything (i.e.
implementing an “exit strategy”) for many months.
- Bernanke & Co. could change it up a bit by implementing what is called a “twist” operation. This is where the Fed would sell short-dated securities and buy longer-dated bonds. The goal
here would be to get longer-term rates to come down.
- Next, the FOMC could cut the interest rate it pays banks on excess reserves. This would encourage banks to get money out of the vault and into loans.
- And finally, the Fed may try to strengthen its commitment to an easy monetary policy via a change in the statement.
According to a Bloomberg survey, 52% of respondents feel the Fed will ease monetary policy further this year via monetary tools and policy language. And of those that feel the Fed will act, 59% believe that Bernanke will communicate that the Fed Funds Rate, the Fed’s Balance Sheet (or both) will remain stimulative for a longer period of time.
The New York Times believe the Fed will likely begin any new (or renewed) campaign with “smaller gestures.”
Thus, those looking for “shock and awe” out of this afternoon’s Fed meeting may be severely disappointed.
S&P 500 - Last 12 Months
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