The Fed to the rescue, again?

Aug. 9, 2011 5:30 AM PT

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The Federal Reserve may not launch a new stimulus plan for the economy when policymakers meet Tuesday, but the central bank almost certainly will try to assure investors that it has a plan, if needed.

The Fed holds its normal mid-summer meeting at a time when stock markets worldwide have been in a free fall, as investors fear that the economic recovery is in serious jeopardy.

The Dow Jones industrial average plunged 5.6% on Monday, to 10,809, after tumbling 5.8% last week. Some broader U.S. market indexes now are in bear market territory, meaning they’ve fallen more than 20% from this year’s highs.

Many analysts believe the Fed will try to boost confidence in its post-meeting statement Tuesday by suggesting that the U.S. economy is better than it looks. The Fed has noted repeatedly that some of the headwinds the economy faced in the first half have faded.

Case in point: Oil prices have reversed. On Monday, U.S. crude oil futures sank $5.57 to $81.31 a barrel, the lowest since November. The price has tumbled 28% from its spring high. That will put at least some money back into consumers’ pockets.

But even if the U.S. isn’t facing a new economic crisis, it is surely facing a new crisis of confidence, egged on by Standard & Poor’s downgrade of the government’s credit rating after the bitter partisan battle in Congress over the federal debt ceiling.

The Fed can’t afford for business and consumer confidence to fall into a black hole. That would make another recession self-fulfilling.

So the post-meeting statement is “likely to talk in detail about possible options” if the economy needs more help, said Anshul Pradhan, fixed-income strategist at Barclays Capital in New York.

Bernanke and other Fed officials have previously spelled out other steps they could take to try to bolster the economy. One would be to pledge to hold short-term interest rates near zero for a specific period -- say, two years -- rather than for an “extended period,” the wording the Fed has been using.

In theory, that could give businesses and investors more incentive to do something potentially more productive with their money than keep it in bank accounts earning nothing.

The Fed also could try to pull long-term interest rates (including mortage rates) down further by reinvesting the proceeds from its $2.65-trillion Treasury- and mortgage-bond portfolio only in long-term Treasuries, such as 10-year and 30-year bonds.

But some analysts say a continuing stock market meltdown could force the Fed to launch yet another massive ‘quantitative easing’ program to buy Treasury debt across the board, in concert with similar bond-buying campaigns by the European Central Bank, the Bank of Japan and perhaps others.

The idea: Keep printing money and injecting it into the financial system, hoping it will kickstart economic growth.

George Goncalves, interest-rate analyst at Nomura Securities in New York said the Fed, the ECB and the Bank of Japan might have to commit to injecting $3 trillion to $5 trillion into the global financial system to have the necessary effect, given that their previous cash injections were insufficient.

‘I think you need shock and awe,’ he said.

That would undoubtedly unleash a new round of inflation at some point. But if Bernanke has to choose between inflation and depression, it should be an easy decision.

‘They will not sit by and watch this thing cascade,’ Goncalves said.

Oil reaches a 2011 low; gasoline prices should fall

Treasury bond yields plunge as panicked buyers ignore downgrade

-- Tom Petruno