‘QE3 is definitely an option’

Chairman Ben Bernanke conceded Wednesday that the U.S. Federal Reserve could consider additional monetary stimulus if the recent economic weak patch persisted.
The mere hint of a new round of quantitative easing was received by jittery markets like a shot of adrenaline. Equities in Toronto and New York spiked immediately and the price of gold hit a record high, while the recent rally in safe-haven assets eased.
“The possibility remains that the recent economic weakness may prove more persistent than expected and that deflationary risks might re-emerge, implying a need for additional policy support,” Mr. Bernanke told the U.S. House of Representatives financial services committee.
Later Wednesday, ratings agency Moody’s Investors Service said it was placing the United States’ triple-A debt rating on a downgrade watch because of rising prospects the U.S. debt limit will not be raised in time to avoid default.
“The review of the US government’s bond rating is prompted by the possibility that the debt limit will not be raised in time to prevent a missed payment of interest or principal on outstanding bonds and notes. As such, there is a small but rising risk of a short-lived default,” Moody’s said in a statement.
Asked whether the Fed would be willing to launch another bond purchase program if the economy slumps, Mr. Bernanke said, “We have to keep all the options on the table. We don’t know where the economy is going to go.”
Mr. Bernanke was delivering his semi-annual testimony on monetary policy, during which he also issued a sharp rebuke to lawmakers for as yet failing to raise the debt ceiling, particularly at a time when uncertainty shrouds U.S. economic projections.
Faith in the U.S. recovery has been rattled with job growth falling far short of expectations in the past two months.
The Fed still believes recent weakness is temporary and expects the economy to rebound in the coming months, discounting the need for additional monetary accommodation, Mr. Bernanke explained.
But that moderated optimism hinges largely on the resumption of robust job creation.
“There is that risk of that spiralling into a double dip,” said Michael Gregory, a senior economist at BMO Capital Markets. “The Fed doesn’t believe it’s the probability or its the base case, but clearly they’re a little bit worried with two lousy months in a row. Three is the making of a trend.”
A single month of decent job growth would offer considerable comfort that recent softness is an anomalous, Mr. Gregory said. “That would be a proof that those couple months of soft patch were really just temporary and that the trend which has been established since the end of last year is the underlying trend.”
Polarizing the debate among economists is the counterpoint that the U.S. economy is fundamentally weak. “One of us will be proven right in the next month or two,” Mr. Gregory said.
The Fed has already outlined its exit strategy for withdrawing stimulus if the economy overperforms.
On the other hand, “the possibility remains that the recent economic weakness may prove more persistent than expected and that deflationary risks might reemerge, implying a need for additional policy support,” Mr. Bernanke said.
That opens the door to a third round of quantitative easing, already being dubbed QE3. “I think it’s quite clear that … QE3 is definitely an option,” Mr. Gregory said.
The previous major asset purchase program, QE2, which saw the Fed soak up US$600-billion in treasuries, officially ended last month.
That program was warranted by developments in both components of the Fed’s dual mandate — to maximize employment and stabilize prices — after the recovery faltered last summer.
Now the Fed again has cause for concern over both jobs and deflation, Mr. Bernanke explained. Complicating that outlook are all the other risk factors that could prove to be somewhat less temporary: slow growth in consumer spending, the dismal state of the housing market, credit limits for consumers and businesses, and fiscal tightening.
“With risks from Europe and ambiguity over the political landscape in Washington, the Fed is just as unsure as anyone else is,” James Marple, senior economist at TD Economics, said in a note. “While they expect economic growth to improve, they are not willing to bet the farm on it and are prepared to do what is necessary if conditions deviate from expectations.”
Financial Post, with files from Reuters

Source: National Post