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Morgan Stanley’s economists were disappointed when the Federal Reserve announced what it’s next round of stimulus would look like. Vincent Reinhart, Chief U.S. Economist, saw an 80 per cent chance of Fed balance sheet expansion in the form of quantitative easing (QE3). But instead, we got an extension of the maturity extension program (MEP), aka operation twist. Reinhart immediately took to Twitter, saying, “Fed action falls short of expectations.”
Matthew Hornbach, Morgan Stanley’s top interest rate strategist, published a research note on Friday reiterating Reinhart’s sentiment:
While the Fed delivered balance sheet action as we had expected – lending further credence to our financial conditions framework – we did not expect the form and composition in which they delivered it. The Fed is likely to get what it paid for.
By not putting forward a more aggressive stimulus, the Fed effectively paid for more disappointing economic data to come. Morgan Stanley thinks this could force the Fed to come back with more stimulus.
We suspect the most likely timing for additional stimulus would be at the December 10-11 FOMC meeting just prior to the end of the MEP. The FOMC is likely to announce their 2015 economic projections at the December meeting – opening the door wider to changes in its “late 2014” rate guidance. If the Fed feels the need to adjust its balance sheet, the next program is likely to be QE3 – and may still involve agency MBS purchases.
So there you have it. The first forecast for QE3.