New recession worries and market havoc posed the toughest challenge yet this year for the US Federal Reserve as its policy board met Tuesday holding a near-depleted box of stimulus tools.

Economists said the Federal Open Market Committee (FOMC), meeting for the first time since its "QE2" asset purchase program ended in June, had few options to overcome stagnating growth and the growing pessimism that sent stock markets on their deepest plunge since the crisis of 2008.

Also under the dark shadows of the eurozone debt crisis, Fed chairman Ben Bernanke and his team will be challenged to shore up confidence in what they have repeatedly called a "recovery" that looks less and less like one.

They were also under international pressure to strengthen the US fiscal balance, four days after Standard & Poor's stunned the country with its first-ever ratings downgrade.

Chinese Premier Wen Jiabao on Tuesday called on "relevant nations" to put their economies in order.

China "demands that relevant nations take concrete and responsible fiscal and monetary policies to trim their fiscal deficits and resolve their debt problems... to maintain global investor confidence," Wen told a cabinet meeting.

US officials are already fending off suggestions of a "double-dip" recession, two years after the 19-month "Great Recession" ended in June 2009.

But analysts say the economy in the second half of the year will remain weak, with Goldman Sachs estimating a one-in-three chance of returning to negative growth, after a one percent growth in the first half.

Already pressure is building on the Fed to adopt a new stimulus program after the expiration of the $600 billion QE2 (the central bank's second round of quantitative easing), though many doubt that more liquidity in the system will help.

"We assume that a further easing of monetary policy will be up for serious debate," said Harm Bandholz at UniCredit Bank.

Almost certainly the central bank will keep its ultra-low, near-zero interest rate in place.

In the first half of the year, the FOMC was divided between a majority who believed the economy remained soft, and a minority who believed the economy was gaining steam and faced a burst of easy money-induced inflation.

But after growth in the second quarter proved to be nearly stagnant, and inflation fell, in July Bernanke told a congressional panel that more stimulus could be merited.

"The possibility remains that the recent economic weakness may prove more persistent than expected and that deflationary risks might reemerge, implying the need for additional policy support," he said.

He said the Fed could follow in the footsteps of QE2 and increase its purchases of US securities, pushing more liquidity into the economy.

It could also cut a key interest rate it pays to banks on their reserves -- which could help push down commercial lending rates, he said.

Goldman Sachs and others expect at least some technical signals to the market from the language in the Fed's post-meeting statement:

- to signal that their low funds rate will stay in place longer than previously suggested,

- and to signal that they will leave the money injected into the market under QE2 (through buying Treasury bonds) longer in the market than earlier suggested.

But that underscores the dwindling number of tools the Fed has in the face of a stalling recovery from the last recession.

Treasury Secretary Timothy Geithner insisted Monday that a new recession was unlikely and that the government does have options to stimulate growth.

"I know there's this perception around there that there's no room for policy, but it's a deeply mistaken perception," he told CNBC television.

"In countries around the world, not just in the United States, we have plenty of room to do things to help make this economy strong in the short term," he said.

A Fed effort to shore up confidence over growth will be crucial as well.

Since Bernanke spoke, the government went to the precipice of defaulting on its debt, before finally raising its own borrowing cap and passing a long-term plan to cut its debt and deficits, on August 2.

But the plan itself failed to impress, and the political battle over it ultimately led to the S&P downgrade -- the act that put equity markets into a tailspin Monday.

Tweet

Related Links The Economy