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NEW YORK (Reuters) – Ben Bernanke put markets on notice this week: Despite already having spent trillions of dollars to stimulate growth, the Federal Reserve would do more if inflation falls too far and the threat of deflation grows.

Bond investors are taking the Fed chairman at his word. If things get worse, some predict the central bank will go beyond targeting interest rates and move straight to outright buying of mortgage securities, municipal debt and even stocks.

“When I think of the Fed I think everything is on the table until it isn’t,” said Eric Green, chief economist and head of interest rate strategy at TD Securities in New York.

If the economy appears on the verge of deflation, the Fed will “have to go very big and be very creative, and that means munis are on the table, mortgage-backed securities, corporate (bonds), equities,” he said. “Everything is possible because the Fed has broken new ground and they will continue to do so if they feel they have to, exit strategy be damned.”

The Fed has pushed short-term interest rates to record lows and last week announced it would attempt to push down long-term rates by selling $400 billion of short-dated Treasuries to buy an equal amount of debt with maturities of seven years and up, in a policy dubbed “Operation Twist.”

This was designed to help the housing market by lowering long-term borrowing costs. It would also encourage investors to sell Treasuries for higher-yielding assets, which should boost stocks and corporate profits, encourage hiring and investment and provide a jolt to consumer sentiment and prices.

THEORY AND REALITY

That, at least, is the theory.

But fear that the economy may already be in recession has been pushing down stocks, commodities and Treasury yields for several months. U.S. stocks are more than 10 percent weaker since the start of August.

As a result, market expectations for U.S. inflation have retreated to levels last seen in September 2010, shortly before the Fed began a $600 billion bond buying program, the second installment of a policy known as quantitative easing, or QE.

When asked about this after a speech on Thursday, Bernanke said, “if inflation falls too low or inflation expectations fall too low, that would be something we would have to respond to because we do not want deflation.

The expected rate of inflation over the next 10 years as measured by the gap between Treasury inflation-protected securities (TIPS) and cash government bonds fell as low as 1.70 percent last week. At 1.83 percent on Thursday, it was still below the Fed’s unofficial inflation target around 2 percent.

St. Louis Fed President James Bullard chimed

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HONG KONG (Reuters) – Asian stocks steadied on Friday with big gains unlikely as investors looked to take profits after three days of gains, while the euro held its tiny increase following Germany’s approval to expand the euro zone bailout fund.

As the curtains come down on the September quarter, the worst for equities since the final quarter of 2008, investors are nursing their losses across all asset classes with traders eager to take profits to spruce up battered portfolios.

In early Asian trade, stocks in Japan and Australia edged higher while Seoul was broadly unchanged.

MSCI’s broadest index of Asia Pacific shares outside Japan was flat after rising for three consecutive days. For the month, it is down around 13 percent, its biggest monthly drop since October 2008.

Even a rare batch of strong economic data from the U.S. failed to cheer sentiment in Asia with traders focusing on China’s September PMI data to gauge how the world’s export powerhouse is holding up in the face of a slowing global economy.

Key indices in the U.S. closed between 0.8 to 1.3 percent higher with U.S. stock futures in Asia holding on to overnight gains.

In currencies, the euro hovered above a eight-month low versus the dollar after German Chancellor Angela Merkel‘s coalition party voted on Thursday to enhance the European Financial Stability Facility’s powers.

Having worked through to $1.3679 at one stage, the single currency settled back at $1.3585 with investors worried about the many problems ahead for the euro zone.

“There is still a lot of uncertainty… Economic growth in Europe and the U.S. is not that good and that will put pressure on the euro and give a bid to the dollar,” said Joseph Capurso, strategist at Commonwealth Bank of Australia.

Worried investors gave the thumbs up to safe-haven bets like gold and Treasuries with the former extending gains slightly to hold $1,622 per ounce.

U.S. crude futures rose more than $1 to as high as $83.17 a barrel in electronic trade on Friday, extending Thursday’s gains.

(Additional reporting by Cecile Lefort in Sydney; Editing by Daniel Magnowski)

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CLEVELAND (Reuters) – Federal Reserve Chairman Ben Bernanke said on Wednesday the central bank might need to ease monetary policy further if inflation or inflation expectations fall significantly.

In his first public remarks since the Fed launched a fresh measure aimed at keeping down long-term borrowing costs, Bernanke indicated a willingness to push deeper into the realm of unconventional policy if economic growth remains anemic.

“It is something that we’re going to be watching very carefully,” Bernanke said in response to questions from the audience at a forum sponsored by the Cleveland Fed.

“If inflation falls too low or inflation expectations fall too low, that would be something we have to respond to because we do not want deflation,” Bernanke said.

The comment was made in response to a question about a recent decline in market-based inflation expectations, which policymakers see as a good gauge of future inflation trends.

The gap between yields on 10-year Treasury notes and their inflation-protected counterparts fell to 1.70 percent last week, the lowest since September 2010. It has edged up slightly since then and last stood at 1.86 percent.

In an effort to stanch the deepest recession in generations and help the recovery, the Fed not only slashed benchmark interest rates to effectively zero, but also more than tripled its balance sheet to around $2.9 trillion.

Despite these measures, growth has remained quite soft, averaging less than 1 percent on an annual basis in the first half of the year. Bernanke signaled he remains concerned about risks to the economy, which the Fed described as “significant” in its September policy statement.

“We have a lot of problems both in terms of recovery and in terms of longer-term growth,” he said.

A TWIST ON HOUSING

Last week, the Fed said it will sell $400 billion in short-term Treasury securities and invest them into longer-dated ones to try to put downward pressure on borrowing costs over a longer period.

Investors have dubbed the program Operation Twist after a similar measure undertaken by the Fed in the 1960s. The central bank will also renew its help to the housing finance sector by reinvesting maturing mortgage bonds in its portfolio back into that market.

Bernanke called for the U.S. government to beef up its assistance to the ailing housing sector, the epicenter of the 2008 financial meltdown.

“Some strong housing policies to help the housing market recovery would clearly be very useful and would allow the monetary policy actions of the Fed … to have more effect and to help the economy recovery more strongly,” Bernanke said.

Asked about the fate of fallen mortgage giants Fannie Mae and Freddie Mac, Bernanke reiterated his view that the mortgage

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SINGAPORE (Reuters) – Asian shares and commodities fell on Thursday on growing worries that Europe’s intractable debt problems will plunge the world into a second global financial crisis.

Copper fell 3 percent, gold slipped toward $1,600 an ounce to stand more than $300 below its record high earlier this month, and commodities-related stocks such as global miner Rio Tinto were dumped on worries that demand will weaken as the international economy slows.

The past week has seen a broad sell-off of commodities, equities and emerging markets bonds and a rally in the dollar that has been reminiscent of the rout surrounding the collapse of Lehman Brothers investment bank three years ago.

“It seems periods of optimism are getting shorter and the pessimism is getting longer,” said David Land, analyst at CMC Markets in Sydney.

“This is being driven by the clear realization that while there are many plans as to how to deal with the Euro situation, the reality of getting agreement will be that much harder.”

Tokyo’s Nikkei share average fell 1 percent, while MSCI’s broadest index of Asia Pacific shares outside Japan dropped 0.8 percent, with its materials sub-index shedding more than 2 percent.

SP 500 index futures were mildly negative, after Wall Street’s broad benchmark dropped 2.1 percent on Wednesday.

“The market situation is still tough, with worries about global growth,” said Fujio Ando, senior managing director at Chibagin Asset Management in Tokyo.

GERMAN VOTE

The latest source of nervousness was a vote in Germany’s parliament at 0900 GMT on Thursday to approve new powers for the euro zone’s 440 billion euro ($598 billion) rescue fund.

While opposition votes will ensure the bill passes, a big rebellion within Chancellor Angela Merkel’s own center-right coalition could weaken her politically and cloud future policy making at a time when financial markets and other nations are urging euro zone leaders to act boldly and decisively.

The euro was a little firmer around $1.3555, while the dollar rose 0.2 percent against a basket of currencies.

“You would suspect weakness until Germany votes, given that it is the big guy that has to fund it,” said Gavin Stacey, head of Australia and New Zealand research at Barclays Capital.

“The euro is most likely to continue its trend deterioration until it gets really bad, forcing a resolution to come.”

Commodities continued to slide, with copper, which is highly sensitive to expectations for global growth, falling 3 percent to $7,036.75 a tonne.

U.S. crude oil futures fell 0.6 percent to $80.70 a barrel and Brent crude lost 0.4 percent to $103.37.

Gold, which has seen a shift from a negative to a positive correlation with riskier assets over the past week or so as investors seeking safety have

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BERLIN/ATHENS (Reuters) – German Chancellor Angela Merkel may fall short of a majority in her own coalition for a crucial reform of the euro zone rescue fund meant to stop a sovereign debt crisis spreading, in what would be a severe blow to her authority, a test vote showed.

Talk of proposals to leverage up the 440 billion euro ($598.5 billion) bailout fund to multiply Europe’s financial firepower lifted global stocks on Tuesday but made it harder for Merkel to unite her fractious center-right coalition.

The Bundestag (lower house) is sure to approve a widening of the scope of the European Financial Stability Facility to aid weak states and banks, agreed by European leaders in July, since the opposition Social Democrats and Greens say they will vote for the measure on Thursday.

But a revolt by Euro skeptical backbenchers hostile to further bailouts in Merkel’s conservatives and their liberal Free Democratic coalition partners may leave her without a majority in her own camp.

In an internal vote on Tuesday, 11 deputies from Merkel’s CDU/CSU group voted against the motion and two abstained. Coalition sources said they expected between 2 and 5 FDP lawmakers to vote against and up to 6 to abstain.

If more than 19 coalition lawmakers vote against or abstain, Merkel will be dependent on opposition votes in a political humiliation that could weaken her ability to push through future rescues.

European shares surged by 4.3 percent in the biggest one-day percentage gain since May 2010 and safe-haven German bonds fell on reports that policymakers were preparing decisive action to tackle the debt crisis.

The cost of insuring Italian, Spanish and French debt against default also fell on hopes of a bold solution, which appear to have little grounding in immediate political reality.

German Finance Minister Wolfgang Schaeuble was forced to deny that any increase in the volume of the bailout fund is planned in a bid to calm irate center-right lawmakers.

“We do not intend to increase it,” Schaeuble told n-tv.

That did not directly address the question of whether the EFSF fund could be leveraged to raise more money to prevent contagion spreading from Greece to Italy and Spain, the euro zone’s third and fourth economies.

LIABILITY

Leverage would make it possible to borrow more, probably from the European Central Bank, for financial firefighting without increasing the EFSF’s size, but critics say it would also raise German taxpayers’ liability for any losses.

Some lawmakers are concerned that EU officials are just waiting for them to approve what they were assured would be the final increase before pressing ahead with bigger bailout plans.

French Finance Minister Francois Baroin made clear there were tactical reasons to avoid discussing

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