WASHINGTON (Reuters) - If the economic recovery falters, there are no easy options left to bolster it.
That is the grim reality facing the U.S. Federal Reserve and the Group of 20 world leaders as both meet this week to plot their policy course.
For the Fed, whose next interest rate decision comes Wednesday, keeping short-term rates near zero is a foregone conclusion. The tough part is how to express its views on the economy without giving false signals on when it might move.
Citigroup economist Robert DiClemente said the Fed will want to acknowledge “new uncertainties” about the strength of the U.S. recovery.
That means it won’t jettison a pledge it first made in March 2009 to keep rates ultra-low for an extended period, because doing so “would seem out of step when the recovery is being questioned,” DiClemente said.
Reasons for the Fed to doubt the recovery include Europe’s simmering debt troubles, poor U.S. job growth, and a wobbly U.S. housing market.
Fed officials have expressed confidence in the recovery’s sustainability, but the worrisome signs might lead them to spend some time talking about what to do if it falters.
With no room left to lower interest rates, the most powerful policy tool remaining is resuming asset purchases, but doing so would no doubt draw fire from those who fear the Fed is sowing the seeds of runaway inflation by printing money.
One of the biggest economic red flags is coming from a lesser-known U.S. economic indicator: the Economic Cycle Research Institute’s weekly leading index.
The index, which comes out every Friday, hit a 45-week low last week. ECRI was remarkably accurate in predicting the latest recession (it peaked around the middle of 2007; the recession officially began in December of that year). It also foreshadowed the unexpectedly strong 2009 recovery.
Now it is signaling a marked slowdown.
For the G20, which meets in Toronto late this week, the economic uncertainty tugs at already strained ties. Rifts have emerged between all three of the major economic players -- the United States, Europe and China.
The transatlantic tension centers on how quickly to rescind stimulus measures the G20 readily endorsed during the depths of the global recession in 2008. Germany has led the charge for fiscal discipline, while the United States has urged its partners to secure the recovery first.
But Europe’s debt troubles have blown up since the last G20 leaders summit in Pittsburgh in September, and that has changed the policy dynamic.
Fiscal concerns have moved to the forefront, which means some G20 countries that readily endorsed huge stimulus packages 18 months ago will be less inclined to open their wallets again if the economy relapses.
As for China, the biggest conflict remains the value of its yuan currency, which many economists say is undervalued by as much as 40 percent. Beijing’s surprise announcement on Saturday that it would gradually make the exchange rate more flexible will likely defuse some of the tension in Toronto.
It drew a warm response from U.S. Treasury Secretary Timothy Geithner, the International Monetary Fund, and the European Commission.
However, some analysts were skeptical that China would swiftly back up its words with actions.
“A lot of people were worried about Toronto being contentious and this likely lessens a blowup,” said Greg Valliere, chief political strategist at the Potomac Research Group.
“But in the words of Ronald Reagan, ‘trust but verify’.”
The Toronto G20 meeting was billed as a final checkup to ensure agreements reached in Pittsburgh would be finalized at a November gathering in Korea, where leaders would then plan for a post-crisis world.
But the crisis refuses to fully subside.
“Our highest priority in Toronto must be to safeguard and strengthen the recovery,” President Barack Obama wrote in a letter to his G20 colleagues. “We worked exceptionally hard to restore growth; we cannot let it falter or lose strength now.”
Jose Vinals, director of the IMF’s monetary and capital markets department, said G20 unity was one of the biggest positive economic developments in recent years, and if it frays, that could damage the recovery.
Vinals expressed concern that the prevailing pre-crisis “do-it-yourself” attitude would re-emerge. The past two years have shown the global economy is closely intertwined, and keeping one’s own house in order is not enough.
“It’s fundamental that you keep your house in order, but it’s also fundamental that when the going gets rough, you cooperate,” he said at a conference in Washington last week.
(For a graphic on ECRI and stock performance, see here)
Additional reporting by Daniel Bases in New York; Editing by Dan Grebler