By Brai Odion-Esene

WASHINGTON (MNI) – With the camps clearly defined, the views of
Bernanke, influential Fed Vice Chair Janet Yellen, FOMC Vice Chair
William Dudley — not to mention swing voters Dennis Lockhart of the
Atlanta Fed and Sandra Pianalto of Cleveland — will be the determining
factor.

Speaking to reporters and analysts during the firm’s mid-year
economic conference call at the end of last month, Wells Fargo’s John
Silvia said a significant, continued downside in the European outlook
would spur the Fed into action, even before a major meltdown occurred.

“I think the Fed is sort of moving in the mode of taking out more
preventive medicine at this point rather than waiting for the total
blow-up in the whole situation,” Silvia said.

B of A-Merrill’s Ethan Harris sees the Fed moving in stages, with
the first action coming next week.

The Fed does not need to see any new, dramatic data, he said, “all
they need to do is see that the economy remains weak.”

Harris said his prediction is that the FOMC extends its guidance
for how long the fed funds rate will need to remain near zero — to the
end of 2015 from late 2014.

“It’s less controversial than doing quantitative easing but it is a
significant step that supports the markets,” he said.

What about QE3? “We are saying September, we have them doing a $600
billion program split evenly between mortgages and Treasuries,” Harris
added.

He said the Fed is taking its time because monetary policymakers
want to be confident that the slowdown in the economy is going to be
sustained, allowing them to make a “very clear case” that they are
acting for economic and not political reasons.

He called the belief that the Fed cannot move around election time
a “myth” and a misinterpretation of the central bank.

They just make sure whatever decision they make is fully justified,
he said.

The September meeting also comes with the added bonus of a news
conference by Bernanke, giving him a platform to explain the motivation
behind any major policy announcements.

“It is nice to have a press conference afterwards when you are
making a really big, controversial move,” Harris said.

Harris added the Fed’s goal is to calibrate its policy to match the
economic situation, and he believes Bernanke “wants to do a policy
that’s big enough to match the risk we are running in this very weak
economy.”

“With each month you become more confident that the slowdown is
here to stay for a while,” he added.

Harris warned that the current slowdown and heightened uncertainty
“is the most dangerous period” of the economic recovery so far, as “it
involves two crises coming together — the European crisis and the U.S.
fiscal cliff.”

“If I’m a Fed guy, I want to have policy that’s big and matches the
scope of the crisis I’m facing,” Harris said.

Jim O’Sullivan, chief economist at High Frequency Economics, also
sees the Fed leaning towards more action and says their case could be
bolstered by Friday’s release of advance U.S. Q2 GDP data.

“If there are big annual revisions, it will certainly be a large
factor in any decisions they make, but the odds are, if any action
comes, it will be in the September meeting,” he said.

“I still think it’s too early to call, or forecast, a QE-type of
action,” Huntington’s George Mokrzan countered.

The Fed is most likely preparing a possible response conditional on
the economy entering “some sort of weaker state,” he told MNI, but said
that is part of normal strategic planning.

“If they feel that actual recession risks are rising, then I think
they would likely to do something or even signal a stronger hand towards
doing something,” Mokrzan said.

However, if the picture remains mixed — raising the possibility
that the economy is experiencing a soft patch as opposed to a real
change in momentum — policymakers will likely wait and see how the
situation develops further, he added.

The Q2 GDP data may have some influence on some members of the
FOMC, Mokrzan added, but he argued that the key is to examine the
programs already implemented by the Fed and what effect, if any, they
have had.

Still, Mokrzan said he understands how a deterioration in U.S.
economic conditions — especially if it happened in conjunction with a
rapidly worsening situation in Europe — could raise the likelihood
“dramatically” that the Fed would act.

Confidence is playing an outsized role in determining the path of
the recovery in the near term, and Mokrzan said the biggest impact any
quantitative easing might have could be on a psychological level — as
opposed to a real increase in monetary stimulus.

“Fed officials may decide that there is little to be gained by
waiting to ease policy, but much that can be lost,” HSBC’s Kevin Logan
wrote. “If the economy is inching closer to recession, then easing
preemptively would be the right thing to do. If, instead, economic
growth is faster than expected, then little harm would be done.”

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** MNI Washington Bureau: 202-371-2121 **

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