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Fed on verge of signaling QE3?

The meeting of central bankers at Jackson Hole at the end of this week could be a pivotal event for the economy and stock markets.

(Federal Reserve Chairman Ben Bernanke ponders his next move (Photo: Bloomberg/Getty)

It wouldn’t be surprising if Ben Bernanke signals QE3 or some other major stimulus during his August 26 speech at the upcoming meeting of central bankers at Jackson Hole. Economic weakness and stock-market sell-offs are again pressuring the Federal Reserve to come up with confidence-restoring moves. Moreover, U.S. fiscal policy is less accommodative this time around, so extra monetary stimulus may be needed to pick up the slack.

If Bernanke does follow through with an announcement, then the days leading up to Jackson Hole could be a good time to add to stock holdings. Indeed, when he signaled QE2 at last year’s Jackson Hole retreat, it marked the start of a lengthy rally in stock markets.

The stimulus could take several forms. It might be buying more government bonds (QE3 option), rolling over maturing debt into longer-term bonds (to push down long-term rates) and/or a cut in interest rates paid on bank reserves held at the Federal Reserve (to encourage banks to lend the reserves out to businesses and home buyers).

Some observers aren’t so sure if QE3 or other major stimulus will be announced at Jackson Hole. One big reason they offer is that the Fed will be sidelined by recent upturns in key inflation gauges. But they are lagging measures. Inflation follows GDP growth, and recent macroeconomic indicators are signaling a slowdown in GDP growth, suggesting the uptick in inflation will be a temporary blip.