Morgan Stanley Chief U.S. Economist Vince Reinhart is calling for another round of Operation Twist — but he thinks we’re more likely to get a third round of quantitative easing.And soon.
Reinhart enumerates three reasons why QE3 is likely, whatever some Fed governors want to think.
- If the Fed is going to act at all, it would have to do so before June to avoid meddling in the political calendar.
- There remains economic slack, and despite how others may feel, inflation is still below the Fed’s target rate of 2%
- Core FOMC members are still not seeing robust economic growth, and Reinhart agrees this is unlikely to change soon. “Anxiety-inducing headlines that the economy is losing steam would be conducive to Fed action,” he writes.
Therefore, at either the April or June meetings, Reinhart predicts there is likely to be a third round of treasuries purchases, in the range of $500 billion to $700 billion.
But that’s not the move he’d pull if he were in charge.
Reinhart argues that a better play would be to “expand the scale and scope of the existing program.” In other words, Operation Twist 2.
Operation Twist 1 involved using proceeds from short-term securities sales to buy longer-term assets.
Reinhart’s sequel involves extending the current purchasing program through the end of the year, which would cost about $400 billion. It would also involve selling shorter-term Treasuries and initiating what Reinhart calls “temporary reserve-draining operations.”
While Reinhart puts the chances of the Fed not acting at one in four, he argues the Fed will seek to preempt any chance that the current mini-rally ends.
And he cites Ben Bernanke’s unique relationship with energy prices as an indicator of where his mind’s at:
“Chairman Bernanke’s academic work on the strong post-WWII association between energy price spikes and subsequent recessions puts part of the blame on the Fed’s historical response. As long as inflation expectations are well anchored, the strong conclusion is that the central bank should ease policy to counter the blow to aggregate demand. Thus, the recent rise in oil prices and the risk that they go higher likely inclines the Fed to do more, not less.”