What Will Ben Bernanke Do to Prevent a Double Dip Recession?

U.S. Federal Reserve Chairman Ben Bernanke will attend an annual central bank conference in Jackson Hole, Wyoming Friday, at which many expect he will speak about disappointing economic growth, downgrade his outlook, and outline plans to fortify the economy and keep growth on track.

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After the central bank’s Federal Open Market Committee announced it would keep borrowing costs near zero through mid-2013, it is unlikely that Bernanke will be announcing any plans involving rates on Friday. Instead he may focus on the Fed’s balance sheet, which allows for various measures, each with its own risk and reward. But a third round of quantitative easing seems unlikely.

The last session of quantitative easing, dubbed QE2, resulted in the Fed purchasing $600 billion in bonds (NYSE:TLT), and was the Fed’s response to historically low inflation that threatened falling prices, consumption, and investment. Now U.S. inflation is higher, as is core inflation, which excludes volatile food (NYSE:RJA) and energy (NYSE:XLE) prices. The concern now is slowing growth, with U.S. financial markets taking a beating as Europe’s sovereign debt woes continue, and the unemployment rate in the U.S. remaining high.

So on Friday, Bernanke could commit to keeping the Fed’s balance sheet at $2.8 trillion, well above the pre-crisis level of around $900 billion, for an extended period of time, or he could put downward pressure on medium to long-term interest rates.¬† According to Deutsche Bank (NYSE:DB) economist Carl Riccadonna, “If the fed does move toward additional accommodation, it may first try to extend the average maturity of its portfolio rather than further expand its asset holdings.”

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Buying more bonds will likely be off the table, though the Fed could do so while simultaneously making efforts to slow inflation by draining bank reserves, which would push down long-term interest rates while removing risk and duration from credit markets. Critics say bond buying would drive down the dollar (NYSE:UDN), in turn driving up commodity prices, but the Fed has historically acted independently, and has a reputation of taking the steps it sees necessary in spite of any opposition, political or otherwise.

No matter what Bernanke has to say Friday, expect a huge market response.