Like over-hyped Olympian, Fed set to disappoint

The US central bank is going into this week's policy meeting with sky-high expectations and a high probability of disappointment. The markets are in need of more easing in order to promote more US growth. However, many are not expecting more stimulus at this moment.

By Jonathan Spicer
July 31, 2012

Pity the Federal Reserve. Like an over-hyped Olympian, the U.S. central bank enters this week’s policy meeting with sky-high expectations and a high probability of disappointment.

Markets are salivating at the prospect of a decisive easing move when Fed policymakers emerge from their meeting on Wednesday. The S&P 500 is up 3.6 percent in the last four sessions as traders hold out hope the Fed will launch a third round of quantitative easing, or QE3, to blast the U.S. economy out of its funk. Stumbling job creation, manufacturing and spending, as well as a measly 1.5 percent GDP growth in the second quarter and serious spillover threats ahead from Europe’s debt crisis, all feed this thesis. Fed policymakers from Chairman Ben Bernanke on down the line to Cleveland Fed President Sandra Pianalto and James Bullard of St. Louis have also stoked the market with a more dovish tone the last little while. And yet, this is probably not the time for a big policy move.

Topping the list of reasons to disappoint – and to knock the market down to size – the Fed probably doesn’t want to front-run the July employment report that’s due on Friday, and which will give a fresh sense whether the spring-summer slump in the labor market is temporary or more permanent. Waiting until the Fed’s next scheduled meeting, Sept. 12-13, would give policymakers the added benefit of the August jobs report. And speaking of front-running, the U.S. central bank may not want to get out just ahead of the European Central Bank’s policy decision on Thursday. If, down the line, things get really ugly in Europe – or if the U.S. Congress sends the country off the so-called fiscal cliff – the Fed will probably want to have the QE3 bazooka ready in its arsenal.

Which brings us to other, less aggressive possibilities when the Fed issues its policy statement Wednesday afternoon. ”I think the Fed can structure the statement in such a way that it would reduce disappointment” by citing, for example, the recent extension of Operation Twist and saying it will act if things don’t get better, said Dana Saporta, an economist at Credit Suisse. Operation Twist, in which the Fed extends its Treasury maturities, is set to run through the end of the year, providing a useful excuse not to act before the November U.S. election. The central bank could also take the relatively modest step on Wednesday of extending beyond “late 2014″ its conditional pledge to keep interest rates near zero, which would give it more time to work on new policy tools that were hinted in minutes from the June meeting.

Credit Suisse estimates that a 33-percent chance of QE3 has been priced into the market, ahead of this week’s meeting. But if the central bank were to unveil such a large-scale asset-buying program, it would probably drop like a confusing thud, given that Bernanke has no scheduled press conference at which he could justify it. ”If they’re going to do something, they probably want time to explain it,” said Sam Coffin, U.S. economist at UBS. The annual Fed conference in late August in Jackson Hole, Wyoming offers that time to explain, as does Bernanke’s press conference set for the September policy meeting.

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