Karim writes:
September FOMC Preview
Its hard to remember going into an FOMC meeting with as wide a range of outcomes and as wide an array of views on those outcomes from markets and economists.
In play:
- Do nothing
- Extend forward guidance (to what date?)
- Cut IOER
- Unsterilized asset purchases
- Open-Ended, or defined amount and time period?
- MBS and/or USTs?
My own, relatively low conviction, view is that they only extend forward guidance, to mid-2015, from the list above. I think there is a 40% probability they announce new LSAPs that would run concurrently with the end of Twist2. If they do additional LSAPs, I think there is a 40% they are open-ended in nature. If they do additional LSAPS (defined amount), I think it will be a 400bn program over 6mths made up of 75% MBS and 25% USTs. The odds of a cut in IOER would around 25% in my view.
Assuming extending forward guidance is a done deal, as hinted in the minutes, here are some of the pro’s and cons in terms of gauging the likelihood of additional asset purchases.
Pros
- The term ‘monetary’ accommodation used in the last Minutes suggests more than just forward guidance is being considered: Many members judged that additional monetary accommodation would likely be warranted fairly soon unless incoming information pointed to a substantial and sustainable strengthening in the pace of the economic recovery.
- Bernanke used the term ‘grave concern’ at Jackson Hole to describe the state of the labor market and the last payroll report looked lousy.
- He defended the use of QE at Jackson Hole, so if the outlook remains weak, why not do more?
Because he doesn’t want to pick a fight with China again, as per my May 2011 post.
Cons
- The Fed states that policy works through financial channels and with most borrowing rates near record lows, and equity markets near 4yr highs, those channels are working well right now. Why mess with success?
Yes, he knows it’s about rates, not quantities, and that policy has caused the term structure of rates to be where it is. However, the channel that remains elusive is how low rates are transmitted to aggregate demand, claims of creating 3 million jobs not withstanding.
- The outlook hasn’t changed much since June when they announced Twist2, so why act now?
- Its 2mths before the election and the Fed is only a side campaign issue now. For an institution that craves it independence, why do anything that may risk that?
Open-ended purchases would likely be tied to the forecast (i.e., ‘the Fed will buy 150bn/mth of MBS and USTs until the Committee is able to forecast meeting its mandate within its forecast horizon’). The issue is the Fed doesn’t have a common forecast (it takes an average of 17 members to produce the SEP). That common forecast is a work in progress (a Committee headed by Yellen). So an open-ended program may take place, but probably not until next year.
Odds of an IOER cut are low just because Bernanke did not mention it at all at Jackson Hole.
About three months ago I suggested the fiscal cliff was too far away for markets to care.
But now it’s a lot closer, and close enough for those to be affected directly by govt spending cuts to be acting accordingly.
But that also means that at least some of that cliff is already being discounted which means:
It won’t be as bad as expected if it happens.
If it’s avoided there will be a boost to the economy not in current forecasts.