Fed doves ‘will not be patient’

July 2, 2012

Ellen Freilich contributed to this post

The Fed did the twist. Will it shout as well? There has been some debate among economists about whether the U.S. central bank might launch a third round of outright bond buys or QE3 given that it just prolonged Operation Twist.

But a truly grim report on the U.S. manufacturing sector from the Institute for Supply Management, if coupled with further evidence of a deteriorating labor market, could certainly induce policymakers to press their foot to the monetary accelerator.

Not only did the index slip below 50 in June, pointing to a contraction for the first time in three years, but the reading of 49.7 was lower than the lowest forecast in a Reuters poll of economists. Moreover, the subcomponents showed the biggest drop in new orders since the aftermath of the Sept. 11 attacks in 2001.

According to Pierre Ellis, senior economist at Decision Economics:

Fed doves will not be patient in waiting for that issue to be resolved – seeing increasing chances of a demand contraction leading to employment weakness and further demand weakness.

The most alarmed are probably pushing for another easing move now, while others might still be calmed by a  strong-enough services-side employment result Friday. If it does not materialize, the normal hesitation in responding to limited numbers of bad data results will probably be overcome by the breadth of the weakness now evident, and by growing perceptions that the economy is much more vulnerable than normal to downside shocks.

Tom Porcelli at RBC Capital Markets is even more categorical, saying QE3 could come as early as the Fed’s next meeting on July 31-Aug. 1:

With both the growth and inflation components slowing sharply, this puts the Fed firmly in play at the August 1 meeting.

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