Greece threw the markets into turmoil as George Papandreou, Greece's Prime Minister, called for a referendum on the second bail-out package that was barely agreed upon by the EU. The call angered his blindsided European counterparts and put in doubt the solvency of Greece and unity of the Euro Zone. At the same time, it also increases the odds that the Fed will lay the groundwork for another round of Quantitative easing or QE3D.
One of the reasons the markets are trying to come back after this latest shocker is they are convinced that the Fed will have no choice to try to work some magic. While Papandreou won backing for the referendum, he may have lost the support of the EU and surrounding uncertainty that this vote will put more pressure the Fed to try to stabilize the global market place.
We already know that Fed officials have been dropping hints that a QE 3 was a strong possibility. The Fed is freaked out by the weak housing market and the high employment rate and the uncertainty coming out of Washington. With a discountenance healthcare bill and regulatory uncertainty, the Fed may try to decide to target these areas and with a twist. By that I don't mean the Twist when the Fed bought the long end of the yield curve and sold the short end to drive down long term rates to encourage long term investment. That was so last Fed meeting. No, a twist by focusing on what they think is the real weak spots in the economy.
One thing they may try is to set a GDP target. In other words they won't just say that rates will stay low until at least 2013 or for an extended period. But will tell people that rates will stay at zero until the GDP hits x percentage. Whether that target will be 5%or 7% would be up to debate but the Fed may try or at least debate something like that to send a message to long term US investors that the Fed has your back.
The other thing the Fed may try is an employment target. Employment of course is part of the Fed's dual mandate and they may try to send a signal that rates will stay at zero as long as the unemployment rate stays below x percentage. Obviously this could be a dangerous game as it may conflict with their other mandate which is price stability or inflation.
The other real strong possibility is that the Fed may just buy massive amounts of Mortgage Backed Securities (MBS) in an effort to spur lending in the beleaguered housing industry. The Wall Street Journal reported a while ago that Federal Reserve officials were starting to, build a case for a new program of buying mortgage-backed securities to boost the ailing economy, though they appear unlikely to move swiftly. The Fed did that in 2008 and 209 and the purchases at that point helped stabilize somewhat the plunging housing market. The Fed may target housing in this most likely scenario.
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