Morgan Stanley's Reinhart Puts The Odds Of QE 3 Over 50%

vincent reinhartVincent Reinhart

Photo: Morgan Stanley

Morgan Stanley top economist Vincent Reinhart and the head of U.S. interest rate strategy Matthew Hornbach say there is now more than a 50 per cent chance the Federal Reserve will use its balance sheet to bolster economic growth.In a video interview for clients, the pair put the chance of QE 3 at 56 per cent, followed by sterilization at 24 per cent.

Sterilization would mean the Fed would offset any actions it takes by selling off other assets it holds, leaving the monetary supply unchanged.

The Morgan Stanley economists see no action from the Fed at just 20 per cent. But with a rapidly approaching election, Reinhart sees increasing pressure for the central bank to act this June.

That means the countdown clock is ticking at the Fed because the closer action is to the election the greater is the risk that it is accused of attempting to favour the incumbent. That does not mean that the Fed would fail to act to significant economic deterioration in August through October, but it means that the bar for more tactical action will be higher and higher as we get closer to the election. Responding to deterioration in financial conditions is a tactical move, and if the Fed does not do so at the June 19 and June 20 meeting, the odds against it go up further.

Hornbach also weighed in on likely purchases the Fed will make. 

We think the Fed will buy both treasuries and agency mortgage backed securities, tilting towards treasuries. Purchasing only treasuries risks disconnecting them from the rest of the fixed income market, and pushing term premiums on securities into more deeply negative territory. Purchasing MBS also gives some diversification and signals that official efforts to spur mortgage modifications are important. Our subjective assessment is that balance sheet action at the next meeting is 80 per cent. There’s a 70 per cent probability that it will be QE3 and a 30 per cent opportunity that it will be a sterilizer program.

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