federal reserve

Does the Fed's script hold a plot twist?

ben bernanke speaking nametag
Highlights
  • The Federal Reserve could serve another helping of quantitative easing.
  • Or the Fed could promise to keep rates near zero percent for even longer.
  • And there's the possibility that the Fed could kick the can down the road.

The buildup surrounding this week's Fed meeting feels like the hype before the premiere of a big-budget movie. (It doesn't feel that way to you? Maybe it's an econ-nerd thing.)

The meeting stars Federal Reserve Chairman Ben Bernanke, who, with his wonky colleagues, is trying to avert a second recession. Members of the Fed's policymaking committee face an uncontained debt mess in Europe, lackluster job growth and political land mines. All eyes, from Wall Street to Washington, are watching for their next move. Will it be a blockbuster or a flop?

"I do think the Fed is poised to do something this week," says Brian Rehling, chief fixed-income strategist at Wells Fargo Advisors. "It's more of a matter of what that something is."

Here are the three possible plot lines for this week's meeting.

Plot 1: Resurrecting QE!

Your favorite Fed character is back: quantitative easing. This is when the central bank prints more Benjamins to buy more securities to drive down interest rates on business and consumer loans. The last two rounds of quantitative easing -- reviewed by Bernanke as a success in a speech in Jackson Hole, Wyo. -- came with large targets, but this time may be different.

"We don't expect the new bond-buying program to be a big $500 billion announcement," says Rehling. "We think it will be more open-ended, maybe commit $50 billion to $75 billion, and revisit it at the next meeting."

The result will likely buoy confidence rather than boost the economy significantly, Rehling says, mostly because everyone is expecting QE3. If the central bank doesn't follow through, the reviews will be bad. Stock markets might swoon for the short term, until another actor catches their fancy.

"The Fed doesn't want that," says Rehling.

Plot 2: New rate guidance

So, instead of the dynamic QE3, the Fed may introduce a new, duller strategy: pledging low rates for a longer time than it already has. At the beginning of this year, the central bank promised to keep the benchmark federal funds rate extremely low (read: near zero percent) through 2014.

"At the very least, the Fed will pledge to keep rates down into 2015," says Paul Edelstein, director of financial economics with IHS Global Insight, an economic forecasting and analysis company.

It's also possible the central bank will tie its outlook on rates to an economic variable, such as the unemployment rate, before raising the federal funds rate, Rehling added. Linking the federal funds rate to another variable could buy the Fed more time before enacting another round of quantitative easing and allow it to avoid acting during a presidential campaign and seeming political.

"That would be their preference so as to not be seen as doing something before the election," says David Barker, president of Barker Financial and a former economist for the Fed.

Plot 3: Same story

Of course, doing nothing would be the most apolitical role for the Fed to take. And there remains the possibility that the central bank stays the course. That means saying that the Fed will step in if the economy requires it, reinforcing the central bank's pledge to keep interest rates near zero percent into late 2014 if the economy continues to need the boost and continuing Operation Twist, its program of swapping short-term securities for longer-term ones to maintain low interest rates.

"I don't think they're ready to act. I think they're still debating internally how effective something like another round of quantitative easing would be," says John Stewart, managing director of Vantage Economics.

Stewart notes the stock markets would love QE3, at least in the short term. But if it fails to produce better job numbers over the next two to three months, then what's the sequel?

"Then we start to talk about the limits of monetary policy," Stewart says, "and start to talk about the need for fiscal policy."

Bernanke himself has repeatedly urged lawmakers to figure out a fiscally responsible alternative to the Draconian spending cuts and tax increases that will automatically start next year if no budget resolution is met.

Get ready for "Fiscal Cliff: The Movie."

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