Fed meeting begins amid uncertainty, slowing economy

The Federal Reserve began its meeting earlier today amid a slowdown in economic growth and a rising clamor for policymakers to take a more aggressive stance on the economy.

Unemployment remains high and the lack of depth to the recovery will do little to create the a significant number of new jobs.  Moreover, weekly jobless claims are holding at elevated levels, suggesting that business confidence continues  to waver.

Another downgrade to the outlook is expected, but analysts are split as to whether the Fed will announce new measures to stimulate demand.

Options on the table

On the one hand, the FOMC may just acknowledge softer conditions, clearly telegraph that it is closely monitoring the situation, and unequivocally state it is ready to take action if conditions warrant. 

Fed Chief Ben Bernanke’s testimony before a Congressional committee just a few weeks ago seems to suggest this might be the most likely option since he spent only a minimal amount of time exploring this path.

However, private sector job growth in July was weak and June’s already small increase was revised downward. Consequently, others suggest that the Fed will announce a new round of “quantitative easing,” or the purchases of longer-term U.S Treasurys.

Small steps in that direction include re-investing the proceeds of maturing mortgage-backed securities into government notes.  A more aggressive approach the Fed might take would include outright purchases of Treasury bonds.

St. Louis Fed Chief James Bullard (see Fed’s Bullard puts spotlight on deflation) recently argued that quantitative easing was needed to counter a slide into the a Japan-like scenario of deflation.

Bullard believes that by buying government bonds, inflation expectations would rise and help prevent a debilitating spiral into deflation.

His plan does come with risks, however, as the Fed could set the stage for another bubble.  Too much stimulus from the central bank also runs the risk of scaring foreign purchasers of U.S. bonds, which could drive interest rates sharply higher.

Whatever today’s outcome, the Fed must delicately balance the need to boost demand without providing too much stimulus that could cause problems down the road.

A look at recent action in the bond market, i.e., falling yields, suggests that traders expect some type of move into Treasurys.