This week's big news is not the Federal Reserve's statement of the obvious. It's the mounting evidence that the Fed can't do much to improve the situation, and the markets' negative response.

Last week, we wrote to you: "The news is in, and it's no surprise. That's why the markets are taking it so well. The U.S. economy is losing momentum. Yet stock prices are rising even as bond yields stay low."

This week, the markets had a different answer.

Saying on Tuesday that the economic recovery is "more modest" than anticipated, the Fed will stop shrinking its huge portfolio of securities by reinvesting the proceeds of maturing mortgages in U.S. Treasury debt. This move is largely symbolic. But it opens the door for bigger purchases of Treasurys or other securities, if necessary. This would be QE2.

After cutting short-term interest rates to nearly zero in December 2008, the Fed spent $1.7 trillion-plus buying bonds through quantitative easing 1, which ended in March. Then the Fed stopped its purchases of mortgage-backed securities and U.S. Treasury debt and began to talk about an "exit strategy." Forget about that now.

The trouble is, QE1 evidently wasn't enough. One reason is that it gave the banks a lot of money to put to good use. But the banks have been reluctant to lend. All they've had to do to profit is to buy longer-term government securities, which have risen in value as bond yields have fallen. In addition, loan demand has been low because of a reluctance to borrow.Read more...