Fed might mull easing, but no action seen

Pressure will build among Federal Reserve policymakers at a meeting next week for measures to pep up a stumbling recovery with a stronger commitment to rock-bottom interest rates.

The Fed is not expected to announce any new measures at its meeting on Tuesday.

But behind closed doors, policymakers could be setting the stage for further action, most likely some form of communication that would bolster a promise of low interest rates as far as the eye can see.

Analysts think that rather than launch a third round of quantitative easing, the Fed is more likely to eventually cement its low-rate vow, perhaps by committing to keep its balance sheet bloated for an extended period or by weighting its securities holdings to longer maturities.

Fed Chairman Ben Bernanke listed communications as first among possible tools in his most recent appearance before Congress.

It's too soon to go to something like a full scale QE3, but it's not too soon to signal concern, said John Richards, head of strategy at RBS Americas. If you lengthen the perception in the market's mind of how long rates are going to stay low ... that pulls down long-term rates as well.

U.S. stocks fell sharply on Tuesday, taking losses for the Standard & Poor's 500 index <.SPX> to 6.2 percent over the last seven sessions, and Treasury bond prices jumped as investors worried about a worsening in recent economic data and the prospect of a downgrade of the U.S. AAA credit rating.

RECESSION WATCH

The Fed's meeting on Tuesday is not expected to produce any immediate change in policy. The U.S. central bank completed a second installment of bond buying, or quantitative easing, worth $600 billion on June 30 and policymakers have said they want to see how the economy evolves before taking any further action.

However, a series of weak economic data has thrown cold water on hopes for a big pickup in growth in the second half of the year and put analysts on watch for signs that could indicate another recession is brewing.

The Fed revised down its growth forecasts in each of its last two quarterly projections, but even so they look on the high side given the recent run of data, and it is likely to register its disappointment in its post-meeting statement.

While Bernanke is a champion of Fed openness, he may be happy to have three more weeks before he speaks publicly. Some analysts see his scheduled August 26 speech at the annual Fed conference at Jackson Hole, Wyoming, as an ideal setting to flesh out details of the bank's thinking.

After additional information about consumer and business spending and sentiment, as well as inflation, the Fed may be in a better position to signal whether it is ready to take fresh steps to spur growth. He used a speech at Jackson Hole last year to pave the way for the Fed's second round of large-scale bond buying, dubbed QE2, to revitalize the flagging recovery.

For the first time since March, officials will not update their forecasts this week or hold a news conference to put meat on the bones of their terse post-meeting statement.

WEAK MANUFACTURING

Within the Fed, officials who skew toward concerns about unemployment believe that if overnight interest rates were at 3 percent, the central bank would not hesitate to deliver a big rate cut. Those officials are likely to advocate additional Fed support for a recovery at some risk of stalling.

At the same time, others have been confident the recovery will accelerate and believe policy is loose enough.

Bernanke made clear in recent appearances that despite high unemployment the Fed isn't ready to ease policy, in large part because inflation has climbed quickly this year, and a number of other officials have said the bar to further action is high.

But reports that manufacturing grew at its weakest pace in two years in July and that the economy expanded at less than a 1 percent annual rate in the first half of the year may change the tenor of the debate.

I think they're in a difficult situation. In terms of inflation, it is above their target and growth is below what they've expected, said John Silvia, chief economist for Wells Fargo Securities.

Policymakers have argued that transitory factors were largely responsible for a sluggish performance in the first half of the year.

They have pointed to high energy prices, supply disruptions from Japan's natural disasters, the euro zone's debt crisis and the recent U.S. debt limit scare as drags on growth.

But the slowdown now appears to be more fundamental in nature. A report on Friday is expected to show employers added a meager 85,000 jobs in July -- not enough to move the unemployment rate down from 9.2 percent.

For the Fed to hit its latest forecast of 2.7 to 2.9 percent growth for the year, the economy would have to expand at an average 3.3 percent annual rate over the last two quarters, but many private forecasters envision growth in the second half of the year at no more than 2 to 2.5 percent.