Equities in the U.S. and Asia fell in tandem after the U.S. Federal Reserve failed to offer new monetary stimulus on Wednesday. While the outcome was largely expected, some observers say it’s not so much what the Fed could have done, but what it should have said.
Although Fed officials said the U.S. economy had "decelerated somewhat," they also held back on fresh measures, dashing expectations among some investors and sending risk assets such as stocks and commodities lower.
According to Randy Kroszner, Former Fed Governor and now Professor Of Economics at University of Chicago’s Booth School of Business, the Fed could have provided a “little bit more guidance” to boost market confidence.
Besides signaling that they would buy more assets in the mortgage markets to lower the borrowing costs of consumers, Fed officials could also be more outspoken on future moves, he added.
“They can also consider some what I call “open mouth” operations, rather than open market operations,” Kroszner told CNBC Asia’s “Squawk Box” on Wednesday. “They’ve made a clear commitment to do something because in the last statement, they said they were prepared to take further action. Here, they say that they will act if things don’t get better. So they could give clearer explanation for what are those conditions.”
For example, the Fed could say they will act when inflation is below their target of 2 percent or when unemployment rate is above 8 percent, Kroszner said.
“They might say, listen, those are the conditions under which we will act,” he added. “And I think that will give a little bit of boost of confidence to the markets.”
Weakness in the world’s biggest economy is weighing on investors, who want the Fed to do more to stimulate growth. The U.S. economy grew just 1.5 percent in the second quarter, slowing from a 2 percent expansion in the first quarter as consumer spending faltered, and unemployment has stayed over 8 percent for six months. slowed sharply in the second quarter to just 75,000 jobs per month from 226,000 in the first quarter.
Tim Condon, Head of Research for Asia with ING, said it might be time for the Fed to do something different if they wanted to kick-start the U.S. economy again. During the peak of the financial crisis in 2008, the Fed expanded its balance sheet by $600 billion by adding new assets and new liabilities. In 2010, the Federal Reserve purchased $1.25 trillion of mortgage-backed securities in order to support the sagging mortgage market.
Condon argues that the previous monetary easing has not worked and it’s time to give the Fed more firepower.
“QE1 and QE2 were time bound and they were limited in size and people looked through them,” he said. “Maybe it’s time they tried monetary easing in the form of an open-ended operation, that is not time bound, to get inflation to a certain level or GDP to a certain level and I think it would be very effective.”
However, not everyone is convinced that further policy moves by the Federal Reserve would do the trick. Another former Fed Governor Robert Heller, said the most important thing now is not for the Fed to provide more stimulus. Instead, the government would have to adopt pro-growth policies.
“They (the Fed) are doing all they can do but what you have to do is take away some of the obstacles to growth,” Heller told CNBC. “The increase in rules and regulations; Dodd Frank rules are being implemented all over the place, Sarbanes-Oxley is still weighing on the economy, and in addition, we have all kinds of environmental rules that are becoming increasingly burdensome to economic growth.”
Similarly, Geoff Lewis, Global Market Strategist with J.P. Morgan Asset Management said there was no need for the Fed to act now because the U.S. economy could rebound in the second half of the year.
“We don’t think the need is likely to arise, at least in the second half of 2012 so it’s about time I think the Fed told investors, don’t look to us all the time for relief and support,” Lewis said. “Don’t look to us to pull a rabbit out of the hat. The U.S. is recovering gradually and so from that point of view, I’m quite happy with the Fed’s inaction.”
- By CNBC's Jean Chua.