What Investors Expect The Fed Will Do This Week

Ben bernanke

Photo: Chip Somodevilla/Getty Images

Investors are jittery ahead of big moves by the world’s two most important central banks right now: the European Central Bank and the Federal Reserve.While the ECB appears poised to make big moves, the Fed appears less poised to take action.

The general consensus amid Fed-watchers and strategists appears to be pointing towards very little action at the Fed’s next policy decision on Wednesday.

Instead, analysts from Deutsche Bank, Goldman Sachs, Bank of America, and other economics research firms say the Federal Reserve could change some minute language to its policy outlook, promising low rates at least until early 2015. While somewhat split on this outlook, they nonetheless see this action as far more likely than another round of quantitative easing.

Extending guidance is a bit of a double-edged sword. On one hand, it stands to reassure investors that the Fed will not tighten credit standards anytime soon, keeping lending rates low. On the other, however, it would indicate that the Fed thinks the economy is likely to remain sluggish for the next three years.

Regardless of the negative signal this sends, investors would see easing credit as a positive for markets, as cheaper lending will help firms and individuals get access to cash.

Quantitative easing, however, is likely on the back burner until September. A report from WSJ’s well-connected Jon Hilsenrath last week indicated that Fed officials see numerous good reasons to save such a move until September, particularly since it would give them a chance to analyse more economic data in the mean time.

Recent statements by Fed Chairman Ben Bernanke indicate that he is most concerned about European financial tensions and China’s slowing growth, not about the fundamental deficiencies of the recovery. Further, recent data indicated that the U.S. economy grew a decent 1.5 per cent in the second quarter—a frustrating, yet not terrible, number.

In a note this morning, Brown Brothers Harriman’s Global Head of Currency Strategy, Marc Chandler, wrote that a lack of major action will probably be a non-event. “Given that market participants seem divided about whether the Fed is prepared to act now or in September, the FOMC is unlikely to disappoint very much.”

Morgan Stanley analysts doubted that even if quantitative easing were imminent, it would be unlikely to generate market enthusiasm for long. From a recent report by Equity Strategist Adam Parker:

Fed action and the specter of more of it continues to create short-term Pavlovian risk-on trades, despite ample evidence that creating money on a computer and buying your own securities doesn’t help the real economy. Or if it does, then I guess Bernanke’s recent protestations to the contrary are disingenuous. The reason we are bearish on multiples structurally is that we see growth as lower and more volatile in the future than in the past.

As numerous economists have reiterated recently, pumping more liquidity into the U.S. economy has diminishing returns. It might be time for the Fed to find some new tools.

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