U.S. Contemplating Another Bailout?

07/19/10 — The economic health picture in the U.S. is getting worse month after month. The choppy U.S. recovery has spawned many conversations at the Federal Reserve about potentially unleashing another emergency bailout. Such conversations are not exactly jiving with the recent G20 sentiment necessitating the pull-back from extraordinary measures implemented to fight the worst recession in a generation. However, recent evidence has the Fed worried that the country simply will not have enough momentum to turn the corner and might again spin out of control back into the recessionary down spiral.

For the time being, the Fed chairman Ben Bernanke has cut estimates for the U.S. GDP, realizing the country’s dismal labor market and sinking into the jaws of deflation could be permanently arresting economic growth. In addition, the Fed is keeping its main interest rate near zero for who knows how long.

On the balance of things, the Fed did not feel that the concern was sufficiently urgent to actually introduce new measures, at least not yet. However, simply talking about additional measures indicates that the U.S. central bank is worried about the recovery’s snail pace
and the limited impact that existing measures and policies have had on the labor market, consumer confidence, and the credit markets.

What additional measures exactly is the Fed discussing? Nothing we haven’t seen before. Potential additional measures could range from moderating market sentiment through wording of the announcements to keeping interest rates at absolute rock bottom for the near future. The wording from last week’s minutes, for example, went something along these lines: “[We] will consider whether further policy stimulus might become appropriate if the outlook were to worsen appreciably.” Furthermore, the Fed has openly acknowledged in the minutes that the outlook has already “softened” quite a bit.

As an unintentional preamble, only hours before the release of the FOMC minutes, three separate economic reports further proved just how soft the outlook really is. Retail sales continued to slide in the U.S. and that is reason all unto itself to worry about the economy,
because consumer spending is what fuels about 70% of it. Furthermore, import prices continue to spin down the toilet to lows not seen since early 2009. Finally, corporate inventories recorded their smallest gains last month, as companies prepared for months
and months of weak and weaker demand.

Opinion polls indicate that most Americans not only don’t believe that the economy is recovering, but they also believe that the economy has either reverted back into a recession or it has never left it. Perhaps the economy has started growing in 2010, but, as far as most Americans are concerned, not much has changed in their financial lives and future prospects. The growth/recovery is obviously still frail and it can easily be run off track, which is making consumers, investors and businesses equally nervous.

Aside from dismal domestic data, the European debt crisis has delivered punches of its own. In June, the eurozone’s problems have pushed the S&P 500 Index down over five percent. Coupled with the estimates that unemployment is going to stay high for a long period
of time, the Fed had little choice but to cut the 2010 GDP predictions from a range between 3.2% and 3.7% to a new range between 3.0% and 3.5%. Additionally, inflation forecasts were also cut to a new lower range between 1.0% and 1.1%, clearly signaling a period of prolonged deflationary price environment.

For the time being, the Fed is only monitoring the situation and weighing macroeconomic factors and their correlations. That also means that institutional investors are also going to step to the sidelines and adopt a “wait-and-see” strategy. With large buyers out of the playing field, I don’t see who will remain in the equity markets to keep the balance of buyers higher over the sellers. This will mean low trading volumes and sideways trading at best, likely resulting in disappointing equity market performance for the remainder of 2010.