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Fed could 'climb aboard QE2' to boost stalled US recovery

When Tim Geithner, US Treasury Secretary, penned an opinion piece entitled Welcome to the Recovery in the New York Times last week, the message seemed ill-timed. Fears are re-emerging about the health of the US economy

By James Quinn, US Business Editor

7:05PM BST 09 Aug 2010

Just days after the US annualised growth rate was found to have slowed from 3.7pc in the first quarter to 2.4pc in the second, and amid continuing concerns about the strength of the rebound in the housing market, for Geithner to write "we are coming back" was seen as ill-judged.

The Atlantic, the weekly US news magazine, called the piece "Tim Geithner's pathetic case for optimism" while one of the New York Times' own readers – a Susan McGregor of Rhode Island – wrote in to say she believed that rather than recovery "a temporary remission" would have been "more accurate".

After last Friday's non-farm payroll figures – showing the US economy lost 131,000 jobs in July, the second consecutive monthly fall – and Goldman Sachs' subsequent 2011 growth downgrade, Geithner's comments looked even more out of step.

Just how out of step will be revealed at 7.15pm on Tuesday, when the Federal Reserve's Open Markets Committee gives its latest prognosis on the state of the US economy.

In what will be one of the most closely watched meetings in some time, FOMC is likely to hold rates at 0pc-0.25pc – for the 17th time in a row.


But it is not for a potential rate change that investors will be watching. Instead, as Goldman Sachs' Ed McKelvey coyly put it, it is whether the Fed will be "climbing aboard QE2 to avoid a double dip?"

The QE2 in question is not the ocean liner – but a second bout of quantitative easing designed to kick-start the economy to prevent it sinking back into another period of negative growth.

Paul Sheard, Nomura's chief global economist, was the first Wall Street economist to argue that Ben Bernanke, the Fed's chairman, and his nine FOMC colleagues should take some form of affirmative action to get the US recovery back on track.

Sheard, in a note published a week ago, argued that the most likely action is for the Fed to "at least stop the passive contraction of its balance sheet".

His comments followed those of James Bullard, president of the St Louis Federal Reserve and a voting member of the FOMC, who said the central bank needs some form of quantitative easing plan.

Of course, as McKelvey points out, the Fed has been here before. The first round of quantitative easing saw the Fed buy $1.7 trillion (£1.1 trillion) of mortgage-related bonds and US Treasuries to resuscitate the economy.

Until now, the process was largely thought to have worked, allowing the Fed to slowly rein in its activities – reducing its balance sheet from the $2.3 trillion it reached at its peak. But economists are now questioning whether the Fed moved too soon.

Speaking before the US Congress last month, Bernanke detailed three ways in which the central bank might step in if needed.

The first was as outlined by Sheard, the second was restarting the asset purchase programme, while the third – the weakest of all perhaps – would be to change the language in the FOMC's much-analysed statement after Tuesday's or subsequent meetings to point out that deflation will not be tolerated.

David Rosenberg, chief economist at Gluskin Sheff and one of the earliest economists to make the deflation "call", noted that "there is growing chatter that the Fed is once again going to come to the rescue".

Indeed the rumour mill includes some form of mortgage-relief scheme to help borrowers suffering from negative equity, while there is also talk of the Fed detailing a new $2 trillion easing programme. There is also talk in Washington of the Fed recycling money redeemed from its earlier easing programme into a new series of asset purchases.

But, despite of the flurry of recent negative economic data, not everyone on Wall Street believes it is time for the Fed to act. Simon Hayes, economist at Barclays Capital, says he has "detected no change" in the Fed's tone in recent weeks, while economist Tom Higgins at Payden & Rygel argues that a double-dip recession remains a "low probability" and as a result the Fed is unlikely to act to "boost economic activity".

Goldman's McKelvey disagrees, however, predicting the Fed will "embrace a new asset purchase programme" if not on Tuesday then at the turn of the year. It will have to be at least $1 trillion to "have a meaningful effect", he claims.

Amongst all this economic debate about the status of the US recovery, it is worth noting that the US National Bureau of Economic Research – the independent arbiter of US business cycles – has yet to declare an end to the 2007-09 recession, meaning that whatever the Fed chooses to do, the US is not quite ready hang up the "Welcome to the recovery" bunting just yet.