The Fed can't (and shouldn't) save the day

@CNNMoney August 4, 2011: 3:36 PM ET
Federal Reserve chairman Ben Bernanke is in a tough spot. The stock market is plummeting and the economy is weakening. But QE3 may not be the answer.

Federal Reserve chairman Ben Bernanke is in a tough spot. The stock market is plummeting and the economy is weakening. But QE3 may not be the answer.

NEW YORK (CNNMoney) -- News flash for harried traders! The Federal Reserve may have two mandates. But placating Wall Street isn't one of them.

Yes, stocks are continuing their, to quote Tom Petty, free fall out into nothing. The Dow was down more than 400 points Thursday afternoon. And yes, the economy seems to be losing steam -- especially the job market.

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Still, several experts said that the worst thing the Fed could do is overreact and launch a third round of bond buying.

This so-called quantitative easing, which investors have already dubbed QE3, may do little to help what ails the markets and economy. It might even make things worse.

Market strategists pointed out that the last round of QE2 (Born: November 2010, Died: June 2011) was one factor that helped lift oil and gas prices earlier this year. That's because anytime you essentially print money to buy debt, you are devaluing your currency.

"Interest rates are already low. There could be unintended consequences from more Fed stimulus," said Stephen Cucchiaro, chief investment officer with Windhaven Investment Management in Boston. "People ran from the dollar and that helped fuel energy inflation after QE2."

Even if Friday's job numbers stink, which they most assuredly will, the Fed still shouldn't hit the panic button. Nonetheless, you can probably expect more people to start clamoring for the central bank to hint that QE3 is coming.

The Fed's policymakers meet next Tuesday (Aug. 9). And what just a few weeks ago was shaping up to be a relative snooze of an event (no press conference from Fed chairman Ben Bernanke, no new economic forecasts) is now something that is undeniably a Wall Street main event.

So what can the Fed do to actually help fulfill its real two mandates of low unemployment and price stability? Sadly, not a heck of a lot.

As I've already explained, more bond buying could be counterproductive from an inflation standpoint. And even though Bernanke is a well-known deflation hawk, it's premature to start fighting that battle again just because stocks are correcting.

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On the job front, a low 10-year Treasury yield hasn't helped inspire confidence. You don't see businesses going out to hire because of low interest rates.

So what good would QE3 do? Unless we're in a competition with Japan for who can have a long-term bond closest to zero, buying more Treasuries accomplishes little.

The bond market is already doing its own version of QE3 after all. Remember how investors were worried that rates would skyrocket because the U.S. still hadn't raised the debt ceiling? What a difference a week makes.

The daily default watch is mercifully over. And guess what? People can't get enough of our debt! The 10 year fell below 2.5% Thursday. That's less than half of a percentage point above the 2008 crisis low of about 2.04%.

In addition, it seems like many developed nations are enacting a sort of coordinated easing. Switzerland and Japan have intervened to rein in their suddenly strong franc and yen.

The European Central Bank kept rates unchanged Thursday -- at a still low 1.5% -- and also pledged to buy more euro zone debt. That's an attempt to stop the bleeding in Italy, Spain and the other PIIGS.

Cucchiaro added that the Fed is still reinvesting proceeds from maturing securities too. So it is not out of the Treasury market.

All that should keep rates in the U.S.-- to use a favorite Fed phrase -- "exceptionally low for an extended period." In other words, the lack of cheap credit is not an issue.

"The economy is not suffering from a lack of liquidity so adding more liquidity is not the right way to solve the problem," said Bob Gelfond, CEO of MQS Asset Management, a global macro hedge fund based in New York. "The Fed should do nothing at this point but there is pressure on them to do the opposite."

It's unfortunate that the Fed may feel inclined to act because lawmakers aren't going to step up to the plate. It's increasingly clear that the 24/7 focus on the deficit means that little will be done in Washington to help the economy now.

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Stimulus isn't just off the table. There isn't even a table for stimulus to be on anymore because Congress set it on fire. Despite that, it's not the Fed's job to ensure the economy grows at a 4% clip ad infinitum.

This may be an unpopular thing to say. But freaking out about the sell-off and weak economic data is silly. Stocks were due for a correction after doubling from March 2009 lows.

And the economic slowdown, while not pleasant, should hardly be surprising. It took us decades of excess to get into the debt mess we're in. Why would any reasonable person think that the economy would experience a miraculous recovery a few short years after enduring the worst crisis since the Great Depression?

I know it seems counterintuitive. But the Fed could show strength by standing pat instead of kowtowing to the fickle whims of the market.

"If the Fed were to do QE3 now, you'd have to wonder why. Are things that bad? With this sell-off, stocks are now down slightly for the year," said Rob Stein, senior portfolio manager with Astor Asset Management in Chicago.

"You should be allowed to have a down year for stocks," Stein added. "I'd be concerned if the Fed did anything. Forget about being too big too fail. People are panicking because they think we may be too big to slow."

The opinions expressed in this commentary are solely those of Paul R. La Monica. Other than Time Warner, the parent of CNNMoney, and Abbott Laboratories, La Monica does not own positions in any individual stocks. To top of page

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