Fed's thinning toolbox lacks oomph

October 14, 2011: 6:27 AM ET
Fed chief Ben Bernanke has been pushing Congressional leaders to make changes to fiscal policies to stimulate the economy.

Fed chief Ben Bernanke has been pushing Congressional leaders to make changes to fiscal policies to stimulate the economy.

NEW YORK (CNNMoney) -- The Federal Reserve has very little left in its bag of tricks to help stimulate the economy. And experts say whatever comes next may not have enough of an impact to pull the economy out of its slump.

That's a far cry from how the year started, when the Fed's second round of bond buying, known as QE2, helped give stocks a much needed boost. By June, the economy remained sluggish and stocks were treading water, raising speculation about the Fed's next move.

The central bank announced that move, known as Operation Twist, at its September meeting.

But that's already packed much less of a punch.

Nearly all of the investment strategists and money managers surveyed by CNNMoney say the Fed's three-week old measure will have a minimal effect on the stock market, and its impact on the bond market is already fading.

If the economy deteriorates further and the Fed initiates a third round of quantitative easing, or QE3, experts are wary of how effective it will be, given how bloated the Fed's balance sheet already is.

"The Fed has done the best that it can," said Steven Goldman, president of Goldman Management. "The impetus behind reliquifying the economy becomes less significant when interest rates are around 1% and 2% -- lowering them further only has nominal effects."

Fed leaves door open on QE3

Even Fed chairman Ben Bernanke has highlighted the limits of the central bank's powers, pleading to a gridlocked Congress to take action to jumpstart the recovery through fiscal policies.

During testimony on Capitol Hill earlier this month, the Fed chief told lawmakers that "monetary policy can be a powerful tool, but it is not a panacea for the problems currently faced by the U.S. economy."

The Fed has been fairly tight-lipped about what exactly Washington should do, in an attempt to stay out of the politics, but has said that the solutions should involve immediate action to spur the recovery, while reducing the deficit over the long-term.

"The government has two major concerns: the housing market and the job market," said Goldman. "They should come up with some sort of sponsorship program to help Americans actually qualify for the low mortgage rates out there, and approve a package to add jobs."

Still, the call on Congress doesn't mean the Fed's toolkit is completely empty.

In addition to QE3, a handful of experts say the central bank may try lower, or even eliminate, the interest rate on bank reserves, in an effort to motivate banks to lend.

The Fed currently pays a rate of 0.25% to banks that park their money with the Federal Reserve, which is pretty handsome when you consider that it's higher than what the banks would be collecting from the open markets, said Mark Luschini, chief investment strategist at Janney Montgomery Scott.

"By not paying banks anything on their reserves, the Fed may force them to find more venues to lend that money rather than earning painfully low yields on it," said Luschini.

CNNMoney survey: Where the markets are headed

The Fed could also vary its language to at least help boost sentiment. For example, in August, the Fed specified it would leave interest rates low until mid 2013, as opposed to the ambiguous timeframe of "extended period" it had been using since 2008.

"The Fed still has a lot in its arsenal, but there are a lot of concerns about their impact," said Luschini. "If they add more liquidity, it will be harder to pull it back in. If they reveal their entire game plan, everyone will know when they'll run out of ammunition. They've got a tough road." To top of page

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