In just a few hours, the Federal Reserve led by Chairman Ben Bernanke will conclude its Federal Open Market Committee meeting and publish is decision on monetary policy.The sentiment on Wall Street seems to be biased toward a major announcement of additional stimulus measures in the form of balance sheet expansion (QE3) or yield curve flattening (Operation Twist).
Economists are largely split on what the FOMC will announce. Some expect no new easing policy at all.
Société Générale economist Michala Marcussen quantified the size of the balance sheet expansion in a Monday note:
With economic data signalling stall speed growth for the US, we expect the Fed to lower its current 2012 growth outlook from 2.7%, narrowing the gap to our own forecast of 1.8%. This -- and the risks from the euro area debt crisis -- will allow the Fed to adopt QE3 at the June 20 FOMC. We estimate the Fed could extend twist by another $150bn, but our expectation is that the Fed will instead allow its balance sheet to expand a further $600bn, with purchases split 40/60% between MBS and Treasuries.
Source: Société Générale
JP Morgan chief US economist Michael Feroli wrote Friday that he sees a 75 per cent chance of an extension of Operation Twist and an extension of zero interest rate expectations:
We see two actions as most likely next week: a change in communications to push back guidance of the path of the fed funds rate, and an extension of Operation Twist. We think there is about a three-in-four chance of the FOMC agreeing to each of these actions.
Source: JP Morgan
BofA expects zero interest rates 'until mid-2015 at the earliest', but no new easing program tomorrow
BofA economists Michael Hanson and Ethan Harris also think the path of the federal funds rate will be adjusted back significantly in order to ease monetary conditions, writing in a note Monday:
We also now think that the Fed will not start hiking interest rates until mid-2015 at the earliest. The exact timing of these actions is a tactical question that depends on deteriorating labour market conditions, lower inflation, and heightened downside risks to the outlook. Thus, we see roughly a 1-in-3 chance of a significant policy easing at the June FOMC meeting. However, we think it is more likely that the Fed releases a very dovish statement and downgrades its forecasts, but otherwise holds pat. This outcome would likely yield at least mild disappointment by the markets.
Source: Bank of America Merrill Lynch
Morgan Stanley said in a note to clients this morning that they see an 80 per cent chance of new easing announced by the Fed on Wednesday:
Morgan Stanley's US Economics Team, led by Vincent Reinhart, recently changed their Fed call. They now see an 80% probability that the FOMC will announce new balance sheet actions on Wednesday. Our base case is that the Fed will announce another $475 bn in outright asset purchases consisting of $200 bn MBS and $275 bn US Treasuries. Across the Street, economists largely anticipate some form of sterilized asset purchases -- an extension of 'Operation Twist.'
Source: Morgan Stanley
Citi's chief US economist Robert DiClemente thinks the Federal Reserve will extend Operation Twist. In a recent note, he writes:
In the absence of worsening stresses and coordinated action that might entail a more aggressive Fed tack, we think the Committee will opt for a modest continuation of the maturity-extension (Operation Twist) program...This might entail $200 billion of matching purchases and sales through the end of the year. A larger balance sheet neutral program could be problematic as it could take too large a share of longer-duration coupons off the market and the Fed could be forced to include sales of slightly longer intermediate notes that might pressure yields higher in a part of the curve that affects private borrowing rates.
UBS chief US economist Thomas Berner sees the chances of additional Fed stimulus to be announced Wednesday above 30 per cent. In a recent note, he writes:
However, the recent bout of global growth weakness raises the risk for a policy response from the Fed. To reflect this, we raise our risk assessment for QE3 to the highest possible 'risk scenario' bracket of >30% from previously 10-20%. The risk of an imminent recession has also risen and now stands at 14%, which is consistent with our previously chosen recession probability range of 10-20%. In the risk scenario, the eurozone crisis intensifies and consequently global economic activity deteriorates further, necessitating a policy repsonse to halt a slide in confidence. The Fed would likely respond by purchasing agency mortgage-backed securities (MBS) and Treasuries.
Deutsche Bank chief US economist Joseph LaVorgna stands apart from most Wall Street economists, saying he sees no new easing announcement coming out of Wednesday's FOMC minutes. In a note out today, he writes (his emphasis):
The level of uncertainty regarding possible policy outcomes is significantly greater than at the past several meetings. We remain of the view the Fed is not going to implement additional policy easing at this meeting, and hence Twist will expire on schedule at month-end. Several policymakers have questioned the efficacy of additional Twist or quantitative easing by openly pondering if the costs would outweigh the benefits. They indicated additional easing would be warranted only if the outlook deteriorated significantly from their current projections; therefore, the near term central tendency forecasts could be the critical determinant of the policy outcome.