According to an article in today’s WSJ, “Federal Reserve officials sent new signals they are seriously considering more actions to bolster the economic recovery but disappointed many investors by not indicating they are committed to taking action.”

The WSJ article goes on to say that yesterday’s release of the Fed minutes “portray an institution in a state of high alert over the economic outlook. Fed officials expressed worry at the meeting about risks to the American economy stemming from the euro-zone debt crisis, the possibility of a ‘significant slowdown’ in China’s economy and the prospect of deep U.S. government-spending cuts and tax increases scheduled to go into effect at year-end.”

The chart below tells why investors were disappointed.  Each time the Fed has provided stimulus in the form of QE or Operation Twist, stocks have rallied.  But by providing this stimulus the Fed risks future costs to the economy such as runaway inflation.  

Even though the economic indicators released since the Fed met on June 19th/20th have continued to be weak (only 80k jobs added and a softening in manufacturing, retail spending and consumer confidence), Fed officials are not yet sure wheteher the recent slowdown in growth is transitory or permanent.

Like I mentioned yesterday, I’m quite confident that the Fed will step-in if the economic numbers show further signs of deterioration in a more permanent manner.  Should this happen, it is less clear to me whether markets will react as favorably given the Fed’s finite set of tools?

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