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Following Bernanke’s testimony in front of the Senate yesterday, Goldman’s Andrew Tilson lays out the options for the Fed’s next move, and what’s most likely to happen.First, he notes that there are four realistic possibilities on the table for more easing.
Pressed to elaborate on what more the FOMC could still do to support the economy, the Chairman described a “logical range” of four monetary easing options: 1) another round of asset purchases focused on Treasuries and/or agency mortgage-backed securities, 2) use of the Fed’s discount window for lending purposes, 3) changes in communication regarding the likely path of interest rates or the Fed’s balance sheet, 4) a cut in the interest rate on excess reserves (IOER), currently 0.25%.
So what’s likely to come next?
What then should we expect from the FOMC at its upcoming meeting on August 1? As previously noted, the lack of inclusion of easing options in the prepared testimony suggests a lower probability of a “big” easing step, at least on the margin. Furthermore, Bernanke has defended the recent extension of the twist as a “substantive” easing; this is one reason why we have been doubtful that another asset purchase program would follow it quickly (see Jan Hatzius, “Bernanke Preview”, US Daily, July 16, 2012). The seemingly biggest easing option on the table, asset purchases, is the most controversial, and any “funding for lending scheme” probably will require somewhat more preparation and planning. This leaves a cut in IOER, which would seem very small by itself, or an extension in the rate guidance. To us, extending the current guidance that rates will remain “exceptionally low….at least through late 2014” seems the path of least resistance should the Fed choose to ease in August or September. Moving the guidance out to mid-2015 would simply maintain the nearly three-year freeze implied by the current guidance when it was originally rolled out in January. The bottom line: our base-case expectation is for an extension of the rate guidance by September, with a larger easing action (asset purchases or a “credit easing” program) in December or early 2013.