The Federal Reserve will be in the spotlight on Tuesday, and every word of the post-meeting statement will be parsed for clues to the Central Bank’s plans.
The panicky stock market losses of the last few days and the growing fears of a recession have forced everyone to start looking back to Ben Bernanke for deliverance. He has done it in the past, most recently with the second round of quantitative easing (QE2) that ended in June. Will the Fed come to the market’s rescue again, with another round of quantitative easing (QE3) program?
I am not convinced that QE3 is the answer to what the markets are worried about. Let’s not forget that a major motivation for QE2 was the fear of deflation that appeared to be taking hold last year. It was not so much jump-starting economic growth, but rather confronting deflationary pressures that the $600 billion bond-purchase program was expected to address. And in fairness to the Fed, QE2 was quite successful on that front.
The issues that have the markets worried this time are many, but the most important one pertains to the uncertain growth outlook. And another round of quantitative easing will do little to address recessionary fears. With interest rates as low as they are, there is not much they can do on that front either. So, there are not many obvious options available to the Fed to address the current market unease.
But one key thing it can do is to come out with an unequivocal economic outlook. They need to reassure us that while growth in the second half of the year may be weaker than what they expected earlier, but there is still enough momentum to keep it in the positive territory.
If they are able to communicate their growth outlook for the second half through today’s post-FOMC statement, then they will have done more than other policy responses could potentially do. Financial conditions will start easing if the markets buy into the Fed’s growth outlook.
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