One thing was clear from the Federal Reserve's Open Market Committee (FOMC) statement in September: if the economy deteriorates, the Fed is prepared to take action. It has readied a new asset purchase plan, which would hope to bring longer-term interest rates even lower and spur economic activity. So will the Fed employ this additional quantitative easing (QE) measure at its next meeting this November? At this point, it's looking more and more like a sure thing for three main reasons.
The Labor Market Isn't Improving
Today, ADP reported its worst initial monthly estimate for labor market activity so far this year, with 39,000 jobs lost in September. That implies that the official government report this Friday will also provide a sobering verdict on employment. Although some jobs were added to the private sector over the past several months, the numbers were too low to even keep up with labor market growth. That combined with Census-related jobs ending has caused the unemployment rate to rise slightly. If the trend is getting worse, instead of better, then the Fed will look to its mandate to reduce unemployment and employ a new QE measure.
The Market Has the Fed Backed Into a Corner
At this point, it sort of looks like the Fed has little choice but to expand monetary policy at its next meeting, because the market expects it. After numerous Fed officials have voiced the view that a new QE measure could help, many investors have already begun assuming that the Fed will take action. Consequently, interest rates have already begun falling further.
In fact, Brian Battle of Performance Trust Capital said this morning on CNBC that the bond market has drove down the 10-year Treasury note recently from around 3% to about 2.4%. Mortgage rates and the dollar have also already begun reflecting an expansion in U.S. monetary policy. Battle says that by the time the Fed would announce a new program in November, the market will already be at least half way to having priced it into securities.
This means that if the Fed doesn't act, then the market could plummet. So it can either act or risk a mini-crash. The last thing central bankers want is more market instability, so they'll feel pressured to take action in November.
Bernanke Prefers QE to More Stimulus Spending
Finally, the Fed officials know that there are two ways that Washington can attempt to stimulate the economy. Either they can take action to expand monetary policy further or Congress can pass more spending and/or cut taxes.
Considering Fed Chair Ben Bernanke's recent indication that he worries about the U.S. deficit, it's likely that the Fed would lean towards monetary policy, instead of fiscal policy, as the safer method to try to reinvigorate the economy. And, of course, it's also far easier for the Fed to exercise its considerable power by employing new QE than to hope 60 Senators will agree on a new stimulus package.
At this point, it would be more of a surprise if the Fed didn't take action in November. That would probably only happen if Friday's jobs number turned out to be shockingly good, the next month provided great numbers for third quarter earnings, and the housing market improved considerably. If none of that happens, it looks like the Fed will unleash another attempt to heat up the economy through QE 2.0.