Money & Politics with Larry Kudlow

More Jackson Hole Shock-and-Awe?

Ben Bernanke’s shocking FOMC announcement on Tuesday — that its zero-interest-rate target would be extended for two more years through the middle of 2013 — drove Dow stocks up over 400 points. But this new policy had no stock market carry-over on Wednesday, when the Dow plunged over 500 points.

The Federal Reserve headquarters in Washington, DC.

But we have not heard the last from Ben Bernanke — not by a long shot.

Buried in the last paragraph of this week’s surprise FOMC announcement was this huge statement: “The Committee discussed the range of policy tools available to promote a stronger economic recovery in a context of price stability.”

This is a brand-new statement. And in all likelihood it was purposefully open-ended. A Fed source suggests that this sort of stuff is usually left out of sight and buried in Fed committee minutes, released well after the FOMC meeting, and not put boldly in the actual policy statement. So clearly, it’s very important.

What might it mean?

When Bernanke speaks at the Fed’s Jackson Hole, Wyoming, meeting on August 26, he could conceivably launch a real shock-and-awe stimulus program. If you go back a year, when Bernanke first announced QE2 at Jackson Hole, sources tell me that the original debate over the quantity of bond purchases had a $2 trillion balance-sheet expansion on the table. Inflation hawks beat that number back to $600 billion. But now the rest of that $2 trillion — or $1.4 trillion — could conceivably be on the table for a new QE3 announcement by the Fed.

A new round of Fed bond purchases would likely be aimed at pinning long-term interest rates down as much as possible. In other words, the Fed will be buying 10-year paper and maybe even 30-year paper to get those yields down even more (10-years are currently around 2 percent). The idea would be to reduce the attractiveness of government bonds and get investors into riskier assets like stocks, or perhaps even new-business and venture-capital start-ups where potential yields look even more attractive. There may even be some job-creation in all this.

Plus, the Fed’s potential Jackson Hole shock-and-awe program could include the removal of the 25-basis-point Fed payment on the $1.6 trillion excess bank reserve now on deposit at the central bank. If the banks no longer earn a safe 25 basis points, they might conceivably lend more.

And if long-term rates come down as per Bernanke’s target bond purchases, mortgage rates might come down even more to the benefit of future and current homeowners.