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All eyes on Bernanke for more stimulus

Aug 26 2011 06:54

Washington - US Federal Reserve chairperson Ben Bernanke takes centre stage on Friday, facing hopes from around the world that he will shore up faith in the US economy and offer more stimulus to boost business.

Bernanke is to address a gathering of central bankers in Jackson Hole, Wyoming on the US economy later on Fiday in what many hope will reprise his speech a year ago, when he signalled the coming of the $600bn "QE2" quantitative easing and delivered a much-needed shot of adrenalin to markets.

But with that easy-money policy having run its course, many are worried the Fed does not have enough left in the way of monetary tools to lift the economy from its near-stagnant pace.

After three straight days of expectant gains, US stocks dropped 1.5% on Thursday as investors turned pessimistic about what Bernanke might be able to offer.

"The market was nervous about (Friday)," said Marc Pado, chief US market strategist for Cantor Fitzgerald.

"He's not going to come out with (a new) QE. It's not going to happen," Pado said.

The landscape for the Fed summit at the resort nestled up next to the stunning Teton mountain range is eerily like last year's: the economy seemed to be stagnating, markets were losing faith in the recovery, and the government seemed unequipped to counter it.

Economists said the resultant QE2 prevented a deflationary spiral, by steadily injecting money into the economy via purchases of Treasury bonds from November to June.

But that did not kick the economy into self-sustaining growth as hoped.

Reflecting the glum outlook after growth ran under a 1% pace in the first half, markets have now dropped back to where they stood last October.

"Contrary to expectations, the US may not have laid the foundation for sustained expansion," said former Fed official Vincent Reinhart, now an analyst with the American Enterprise Institute.

"The chance that the economy slips into another recession within a year is about four in ten."

Bernanke does have some tools but not a lot, and no one is certain whether they will have the desired impact.

He could launch a QE3, or signal that the Fed would make unscheduled QE2-like purchases if and when the economy needs it.

A $1 trillion dollar QE3 could increase gross domestic product growth by up to 0.5% over one year, said Goldman Sachs economist Sven Jari Stehn.

But that is not a lot of bang for the buck, and "is unlikely to be a panacea for growth", he said.

Not many choices

Another possibility is to cut further, or to zero, what the central bank pays commercial banks for parking their reserves with it - or even charge them for the favour.

That could prod the banks to lend to or invest in more risky, higher-return activities, stimulating business. But it could also turn into more speculative activity that would serve just to drive up commodity and asset prices and not generate jobs.

The Fed could also adjust its mortgage purchases - ongoing as it continues to roll over its $600bn QE2 investments - to push down both long-term bond and mortgage rates.

That, say analysts, could unleash more money to longer-term investment, by both companies and consumers.

"By lowering long-term interest rates even further, it in effect encourages risk-taking," said Nariman Behravesh, chief economist at IHS Global Insight.

For instance, he said, there is a "huge pent-up demand" for housing.

"The Fed could potentially tip the balance in terms of people being more willing to make those bets, those big investments," he said.

But still, Behravesh conceded, "The dilemma that that the Fed faces is that there are not a lot of choices here.

"The best thing (Bernanke) can do on Friday is to project a sense of confidence: 'Yes, we know what is needed, yes we will do it if it is necessary'."

ben bernanke  |  markets  |  us economy


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