What Is the Fed Saying?

With nothing major on the economic docket on Wednesday, stocks will likely continue to chew over the Fed’s Tuesday statement. We got a head-spinning rally in stocks Tuesday afternoon following the release of that statement, meaning that investors found plenty to be happy about in the Fed’s posture. But what did the Fed really say?

To be fair to the Fed, they don’t really have a lot of policy options at their disposal. Interest rates are already quite low and further deployment of their enormous balance sheet (another round of QE) is not without its fair share of detractors, including within the Fed.

But the Fed was able to show some progress on both of those fronts (interest rates & QE) without explicitly doing anything. With respect to interest rates, they gave us an explicit timeframe; telling us in plain language not to worry about interest rate hikes for another two years. Bernanke didn’t have all his FOMC members onboard with this change as three regional Fed presidents voted against it.

On the question of further quantitative easing, the Fed appeared to be laying the ground work for more action down the road. They stated that the economic growth outlook had soured, but inflation was subdued, and that the labor market was weak. The primary within-the-Fed opponents of further quantitative easing rely on inflation readings. And if inflation remains under control while macro conditions continue to deteriorate, then QE3 may very well be in the cards in the coming months.

The FOMC reportedly discussed a range of policy tools at its disposal to promote economic growth in the context of price stability. Early indications of QE2 emerged from last year’s Jackson Hole retreat; it will be interesting to listen to the speeches in this year’s iteration later this month.

Quantitative easing may not be the solution to what is ailing the U.S. economy at this juncture. But in the absence of any fiscal response given the political gridlock, this may be all we can expect in the current environment.

All these macro issues have completely pushed earnings news from the headlines, though we are not done with the second quarter reporting season yet. We got a solid top- and bottom-line beat from Macy’s (M) this morning, while Disney (DIS) came out ahead of expectations after the close on Tuesday. Cisco (CSCO) reports after the close today.

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