By Steven K. Beckner

(MNI) – Although the economic outlook remains very uncertain,
speculation about a near-term return to quantitative easing is almost
certainly premature.

There may well be discussion of the Fed’s options for providing
additional monetary stimulus at the Sept. 21 Federal Open Market
Committee meeting, but it is doubtful whether the FOMC will actually do
so. And action at subsequent meetings is highly contingent on
developments.

In his Aug. 27 speech to the Kansas City Federal Reserve Bank’s
annual Jackson Hole symposium, Fed Chairman Ben Bernanke made clear he
is prepared to go beyond the FOMC’s Aug. 10 decision to halt shrinkage
of the Fed’s balance sheet through reinvestment of maturing mortgage
bonds proceeds in longer term Treasuries.

“We will continue to monitor economic developments closely and to
evaluate whether additional monetary easing would be beneficial,” he
said.

“In particular, the Committee is prepared to provide additional
monetary accommodation through unconventional measures if it proves
necessary, especially if the outlook were to deteriorate significantly,”
Bernanke added.

He made clear that his preference, in that event, would be net new
purchases of longer term securities. He said the FOMC would have to
weigh costs and benefits.

After giving a somewhat less optimistic assessment of
the economy, Bernanke laid out broad conditions for additional stimulus:

— “First, the FOMC will strongly resist deviations from price
stability in the downward direction … . If deflation risks were to
increase, the benefit-cost tradeoffs of some of our policy tools could
become significantly more favorable.”

— “Second, regardless of the risks of deflation, the FOMC will do
all that it can to ensure continuation of the economic recovery
… . Because a further significant weakening in the economic outlook
would likely be associated with further disinflation, in the current
environment there is little or no potential conflict between the goals
of supporting growth and employment and of maintaining price stability.”

Minutes of the August meeting show little opposition to stabilizing
the balance sheet. But, when it came to going beyond that to expanding
the balance sheet, the minutes say only “several members emphasized
that … the Committee would need to consider steps it could take to
provide additional policy stimulus if the outlook were to weaken
appreciably further.”

Has the economy “deteriorated significantly” or “weakened
appreciably further?” It would be hard to argue at this stage that it
has.

True, the Commerce Department revised its estimate of
second-quarter GDP growth down from 2.4% to 1.6%. And the Fed’s beige
book survey of conditions around the nation, findings of which will be
reviewed by the FOMC next Tuesday, found “widespread signs of a
deceleration compared with preceding periods.”

But the August employment report was better than expected. The
one-tenth uptick in the unemployment rate to 9.6% was caused by a rise
in the labor force. The 54,000 dip in non-farm payrolls was less than
expected and was due to lay-offs of census workers. Prior months’
payrolls were revised sharply higher, and private jobs were up 67,000.
What’s more, the latest week’s jobless claims were down by 27,000.

Retail sales rose for the second straight month by 0.4% in August.
Excluding motor vehicles, sales are up 0.6%. Both figures are better
than expected and show a modest pace of growth in third quarter consumer
spending.

July store sales were lower than first reported, and much of the
August strength is due to higher commodity prices which swelled the
volume of food and gasoline sales. But the trend is better and has
continued in September, according to chain store sales from the
International Council of Shopping Centers.

The Fed’s own industrial production index out earlier in the day
rose 0.2% as expected. Manufacturing output was also up 0.2% despite a
drop in auto production.

While none of these data show a robust recovery, they do not
suggest the kind of “significant deterioration” Bernanke said the FOMC
is looking for to warrant renewed quantitative easing. Nor has there
been evidence of intensified disinflation. Indeed, core import prices
rose 0.2% in August after two straight monthly declines.

Note that the FOMC won’t be going through its quarterly forecasting
exercise until the Nov. 2-3 meeting, which happens to roughly coincide
with the mid-term election — not traditionally a favored time for
major policy changes.

What’s more, as MNI has reported before, there is not unanimous,
wholehearted support for renewed quantitative easing, at least not in
the current climate. It is known that there are FOMC members who would
readily back it, but others would be much harder to bring along.

For example, Dallas Fed President Richard Fisher, who will be an
FOMC voter next year, recently said firms are reluctant to hire and
invest because “politicians and officials who craft and enforce taxes
and rules have been doing so in a capricious manner.”

And Fisher said that in turn make him “reluctant to (support
renewed quantitative easing) unless or until fiscal and regulatory
initiatives are aligned with the needs of job creators.” He later told
reporters the Fed has done “as much as is prudent.”

Others have their own misgivings.

Some have exhibited caution about proceeding with more stimulus.
St. Louis Fed President James Bullard, a current FOMC voter, has said he
would support additional purchases of Treasury securities, but only
under certain conditions.

“Today, with core inflation at low but manageable levels and the
economy expected to continue to expand, no action is necessary,” Bullard
said. “Should economic developments suggest increased disinflation risk,
purchases of Treasury securities in excess of those required to keep the
size of the balance sheet constant may be warranted … . If the risk of
further disinflation builds, Fed action may be warranted.”

Some warn that wading back into asset markets would accomplish
little, while exhausting the Fed’s dwindling ammunition.

Others fear that expanding the balance sheet will complicate
the Fed’s eventual exit strategy, create perceptions that the Fed is
accommodating Treasury borrowing and potentially build long-term
inflation pressures.

Under the right conditions, Bernanke could undoubtedly get
sufficient support for additional purchases of Treasury securities, if
not of mortgage backed securities.

But while “Q.E. II” may yet sail, for now it remains in port.

** Market News International **

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