Twisting in the wind

The Federal Reserve is looking helpless until at least 2013. The US central bank’s rate-setting committee on Wednesday bewailed slowing US growth but made no policy changes. Absent crises, more quantitative easing this year is unlikely. A new third round of QE may anyway be more effective in theory than in practice. After the US election, though, the Fed may face much tougher choices.

The Federal Open Market Committee’s statement noted that economic activity decelerated in the first half of this year. However, it gave eager market-watchers little, if any, additional hope of further easing any time soon. That is sensible. Fed policy has now been ultra-loose with short-term interest rates essentially zero, and well below the level of inflation, for nearly four years. Fed Chairman Ben Bernanke is wise to keep QE3 in reserve, perhaps never to be used, rather than deploying it to little effect and emptying his arsenal.

There are three more FOMC meetings this year - two before the November election and a third in December. The last of these will take place when the new president and congressional make-up are known, along with the likely general direction of fiscal and economic policy. However, it’s also probable that negotiations will be under way in the lame-duck Congress to address the so-called fiscal cliff of tax increases and spending cuts due to come into effect on January 1. The Fed will not want to disturb those negotiations, and anyway the new administration won’t take office or propose concrete changes until January.

That leaves the Fed most likely on hold for at least about six months. Steady if sluggish growth with no further monetary interventions may be no bad thing. If anything, it may allow time for Bernanke to adjust himself and markets to the idea of interest rates eventually going up. Either way, investors will have to get used to the recently all-powerful Fed sitting on the sidelines.