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After 635-point sell-off, Fed running out of options

It's unlikely the Fed will introduce another round of quantitative easing, say some observers

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Federal Reserve Chairman Ben Bernanke testifies on Capitol Hill in Washington, Thursday, July 14, 2011, before the Senate Banking Committee hearing to deliver the semiannual Monetary Policy Report. The Fed will meet on Tuesday, Aug. 9. Will the Fed announce a new plan to step and attempt to calm the markets?

Susan Walsh / AP

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By Patrick Allen, CNBC.com

The Dow fell by 635 points, Asia followed suit and Europe is expecting losses for up to 6 percent following the downgrade of US debt by ratings agency Standard & Poor’s. Whether the move by S&P can be wholly blamed for the heavy selling of stocks is open to question, but the market is now asking how the Fed will react when it meets today to discuss its response at its monthly meeting.

Last month, Federal Reserve Chairman Ben Bernanke outlined four actions he could take: More quantitative easing; cutting interest on excess reserves; buying longer-dated bonds, or giving guidance on when he will begin to shrink the Fed’s balance sheet. All options open to the Fed chairman, and following the huge losses for stocks since late last week, the Federal Open Market Committee will on Tuesday have to take all options very seriously.

“Judging from the experience with QE2, another round of asset-purchases might be the Fed’s best option to resuscitate the stock market in the short-term,” Harm Bandholz, the chief US economist at Unicredit Research, said in a note to clients following what he described as “Black Monday.”

Noting that stocks rallied by 30 percent following the announcement of QE2, Bandholz said he thinks it unlikely that the Fed will push the button on QE3 despite the sense of panic following the 635-point loss for the Dow on Monday.

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