As global markets await hints of further stimulus in Fed Chief Ben Bernanke's annual speech at Jackson Hole, Wyoming, this week, one strategist says the U.S. central bank may be forced to take extreme measures to prop up the U.S. economy.
"If the Fed really is going to go down the route of another round of unconventional policy making, I think they've got to go in for, what I called, shock and awe," Russell Jones, Global Head of Fixed Income Strategy at Westpac Institutional Bank told CNBC on Monday.
"The problem from Bernanke's point of view is that, really, he is beholden to price action in equity markets, which is not something really where any central bank wants to be."
Jones believes the pressure on Bernanke to respond with a policy move will be "absolutely overwhelming" if the U.S. stock market sees further selloff. He thinks the trigger point would be a decline of a further 10 percent from the current levels. The recent stock market rout has already wiped out more than 10 percent from major indices.
"If we really are in trouble at the end of the week, I think they'll have to respond," Jones said.
Pressure has been mounting for the Fed to take to take action - possibly a third round of stimulus or quantitative easing 3 (QE3) – after recent data, particularly the Philly Fed manufacturing indexand weekly jobless claims, pointed to continued economic weakness.
Still, higher inflation and the Fed's already pledging to keep interest rates low till 2013 have many thinking there may not be anything new at Jackson Hole later this week.
But Jones thinks otherwise.
"Aggressive or dramatic weakness in the stock market probably trumps any fears about inflation, and that would dominate," he said, adding that "the Fed would seek to look through an inflationary threat and offer up a policy response."
He believes there may be some effort by the Fed to extend the maturity of its balance sheet, though this would only be an incremental policy move.
For more impact, Jones says the Fed should launch a much bigger quantitative easing program than the previous two rounds, including formally targeting longer term interest rates such as setting the 10-year Treasury at 2 percent or lower for an extended period and allowing the balance sheet to expand to whatever level is necessary to achieve that aim.
"That would certainly be shock and awe, and I think that might generate a more positive response in stock markets."