By Steven K. Beckner

Continued

In Oct. 4 Congressional testimony, Fed Chairman Ben Bernanke said,
“the recovery is close to faltering.” And he said “we need to make sure
that the recovery continues and doesn’t drop back.” He said “we are much
further away from full employment than we are from price stability.”

What’s more, Bernanke slightly amended a key clause in the FOMC’s
Sept. 21 policy statement to make it somewhat stronger. He said the
Committee is “prepared to take further action as appropriate to promote
a stronger economic recovery in a context of price stability.” The
FOMC’s Sept. 21 statement had said it was “prepared to employ its tools
as appropriate.”

Bernanke was less assertive in his latest outing, an Oct. 18 speech
in which he said the FOMC is “committed to stabilizing inflation over
the medium run while retaining the flexibility to help offset cyclical
fluctuations in economic activity and employment.”

But his top lieutenants have continued to indicate a willingness to
provide more monetary stimulus at some point.

Monday, New York Fed President William Dudley said he does “not
think that monetary policy is all-powerful” and said “we need
reinforcing action in areas such as housing and fiscal policy.” But the
FOMC Vice Chairman later told reporters “the Fed is doing — and will
continue to do — everything in its power to promote jobs and price
stability. I don’t think the Fed has run out of bullets.”

“It’s possible we can do another round of quantitative easing,”
said Dudley, who didn’t rule out buying mortgage backed securities in
some future QE3 “depending on how the world evolves.”

Last Friday, Fed Vice Chairman Janet Yellen said the economy faces
“significant downside risks” and said the FOMC is “prepared to employ
our tools as appropriate to foster a stronger economic recovery in a
context of price stability.”

Yellen also said “securities purchases across a wide spectrum of
maturities might become appropriate if evolving economic conditions
called for significantly greater monetary accommodation.”

But none of these comments mean that the FOMC is likely to inject
more monetary stimulus next week so soon after it has adopted other
easing measures (the $400 billion “operation twist,” the changed MBS
reinvestment policy and the extension of the zero federal funds rate
forward guidance through at least mid-2013).

Yellen was speaking in the context of not wanting to distort the
long-end of the Treasury market in the event that the FOMC does decide a
third round of quantitative easing is needed. She prefaced her comment
about buying “across a wide spectrum” by saying that “purchasing a very
large proportion of the outstanding stock of longer-term Treasury
securities could potentially have adverse effects on market
functioning.”

There are members of the FOMC who have made very clear they are
ready to act soon — not just to reduce unemployment but to counter what
they see as nascent disinflationary trends.

For instance, Fed Governor Daniel Tarullo said last Thursday “there
is need, and ample room, for additional measures to increase aggregate
demand in the near to medium term, particularly in light of the limited
upside risks to inflation over the medium term.” He said the FOMC
“should move back up toward the top of the list of options the
large-scale purchase of additional mortgage-backed securities (MBS).”
Chicago Fed President Charles Evans has also been an advocate of strong
Fed action.

But even Tarullo wasn’t calling for immediate further easing. He
said that “in the absence of favorable developments in the coming
months, there will be a strong case for additional measures.”

Presumably, the need for more easing will be judged on the basis of
how the economy performs relative to the revised quarterly forecasts
which the FOMC will be compiling next week.

What economists call “exogenous” shocks could be a big factor going
forward.

Although the European debt crisis may have been put on hold for
now, financial and economic conditions in the U.S. remain vulnerable to
other downside risks. Already, the focus is shifting to Congress’
so-called “Super Committee” which faces a Nov. 23 deadline for fleshing
out the deal struck in early August to cut the federal deficit by at
least $1.2 trillion over 10 years.

Failure to follow through on promised debt reduction, which could
bring with it further downgrades of the U.S. government credit rating,
could cause more havoc on Wall Street and increase the climate of
uncertainty which many Fed officials say is holding back the economy.

If the recovery does, in fact, “falter,” and if the inflation rate
falls below the FOMC’s 1.7% to 2.0% target range, as some warn, then QE3
will be very much on the table. But that time is not now.

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** Market News International **

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