Strategic Briefing – Is the Fed Set to Roll Out QE3?

Fed Leaning Closer to New Stimulus if No Growth Is Seen
The New York Times | July 24
A growing number of Federal Reserve officials have concluded that the central bank needs to expand its stimulus campaign unless the nation’s economy soon shows signs of improvement, including job growth. The question is expected to dominate the agenda when the Fed’s policy-making committee meets next week, with some members pushing for immediate action while others seek to delay a decision at least until the committee’s next meeting in September, so they can see a few more weeks’ worth of economic data.

Fed Moves Closer to Action
The Wall Street Journal | July 24
Several officials have expressed both frustration with the disappointing recovery and a willingness to act if growth and employment don’t pick up. Sandra Pianalto, president of the Cleveland Fed, said in public comments earlier this month she would be prepared to act if weak economic data persisted. Dennis Lockhart, the Atlanta Fed president, said more action could be needed barring a “step-up of output and employment growth.”
Fed “hawks”—who tend to worry more about inflation and have opposed more action to stimulate the economy—have softened their tone and acknowledged the frustration. “I know people feel like we haven’t made enough progress,” James Bullard, St. Louis Fed president, said in an interview this month. He said he would be prepared to act if inflation falls too low or if a new shock hits the economy.

Fed Focus: Fed strives to replenish depleted toolkit
Reuters | July 25
A recent Reuters poll of U.S. primary dealers, banks that do business directly with the Fed, found that 70 percent expect another round of stimulus via bond buys. But yields on Treasuries are at or near record lows, casting doubt on what good yet more purchases can bring. Little action, if any, is expected at the next policy meeting, July 31-Aug. 1, when some economists think the Fed could push further into the future its conditional pledge to keep rates near zero through late 2014.

Show some real audacity at the Fed
The Financial Times | July 24
Quantitative easing that fails to spark risk-taking could actually make things worse…. And so the Fed faces a dilemma. With inflation below target and unemployment far above the neutral rate, there is a clear case for stimulus. But the familiar tools of stimulus seem unlikely to work. So the markets expect next week’s Fed policy meeting to produce more equivocation. The better way forward would be to come up with new tools. One possible measure is to cancel interest on excess reserves. At present, the Fed pays 25 basis points to banks that deposit cash with it, a perverse reward for keeping money inert. Eliminating that incentive might steer cash into the real economy. But it would also drive cash into the money markets, where returns would soon fall to zero or lower. Money market funds would be hard-pressed to avoid breaking the buck again. Panic might follow. That leaves a second option: the Fed could couple more quantitative easing with a formal announcement of a higher inflation target.

This post originally appeared at The Capital Spectator and is posted with permission.