Economic Outlook: Slip-sliding away

By ANTHONY HALL, United Press International  |  Aug. 10, 2010 at 8:48 AM
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Analysts say Federal Reserve policy makers will signal a shift in the economic recovery after Tuesday's meeting in Washington. Beyond that, who knows?

It is open to question what the Fed might do about a recovery that is slipping away, but the first task at hand is to name the problem. Is deflation an imminent threat? Some on the Fed's Open Market Committee say it is, including Boston Fed President Eric Rosengren and St. Louis bank President James Bullard, who recently warned a potential "Japanese-style deflationary trend" could be developing.

Recently added to the list of deflation-spotters is former Fed chairman Alan Greenspan, who said Friday, "It strikes me as a pause in the recovery, but a pause in this type of recovery feels like a quasi-recession," The New York Times reported.

Greenspan also said: "At this particular moment, disinflationary pressures are paramount. They will not last indefinitely."

Greenspan's comments may well mark the difference between quarterbacking on the field and quarterbacking from the sidelines. Entrenched in its "first, do no harm" mentality, the Fed has not whispered any official consensus on deflation. The last FOMC communication June 23 said the "economic recovery is proceeding." After six months of job growth, the labor market at that time was "gradually improving," the Fed said.

This month, many are betting the Fed will change its tune. The Times quoted former Fed governor Randall Kroszner as saying, "I think the language will broadly change to acknowledge the moderation in the pace of the recovery."

But many are also saying the Fed has limited options for what to do with a recovery that is slipping through its fingers. Each move the Fed could take has risks, including the simple possibility of announcing now that its key lending rate will remain low for longer than previously considered.

The Fed has already said, consistently, the rate will remain low "for an extended period," a vague enough directive attached to anecdotal evidence that implies "extended" means six months.

But changing that language to imply a longer period of low interest rates would needlessly be a way for the Fed to signal it is closing one eye on the very remote possibility of an unforeseen inflationary trend. The Fed is not likely to close one eye voluntarily.

Analysts say the Fed could also re-invest in mortgage-backed securities, adding to a portfolio that includes $1.25 trillion in such securities purchased in the past year. That gesture, to put proceeds of those purchases back to work, would be more of a signal than a major market influence, analysts say. But it could also signal to some the Fed is unconcerned with rising government debt. That means Fed governors would be swimming against the political tide, which has adding to debt as popular as raising taxes.

In addition, mortgage interest rates continued to drop, reaching historic lows even after the Fed stopped purchasing mortgage-backed securities in March. That takes away the rationale that more quantitative easing is necessary to help the struggling housing market.

Markets movement is likely to be muted Tuesday in anticipation of the Fed's afternoon announcement, even if the announcement sounds like, "the recovery is slipping away, but our hands are tied."

International markets turned lower Tuesday after mostly positive trading on Monday. In Japan, the Nikkei 225 index lost 0.22 percent while the Shanghai composite index in China lost 2.89 percent. The Hang Seng index in Hong Kong fell 1.5 percent while the Sensex in India dropped 0.37 percent.

In Australia, the S&P/ASX 200 lost 1.18 percent.

In midday trading in Europe, the FTSE 100 in Britain slid 0.37 percent, while the DAX 30 in Germany lost 0.78 percent. The CAC 40 in France fell 0.64 percent while the pan-European DJ Stoxx 50 lost 0.58 percent.

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