FOMC: Let’s Twist Again?

At this week’s meeting of the Federal Open Market Committee (FOMC), there is a reasonable chance that the Fed will at least drop a strong hint that more monetary help is on the way. Following yesterday’s Greek elections and the rather stunning jump in Spanish bond yields, equity markets left on their own would probably react by pushing down asset prices and pushing up interest rates. Neither would improve the US economic outlook for the rest of this year.

An increase to ‘Operation Twist’ is probably the most likely first step. Recent comments by Fed officials, including chairman Ben Bernanke have indicated that the central bank is prepared to step in if the outlook for economic growth turns sour. Swapping short-term Fed assets for longer-term assets carries less risk, but it is also less likely to make a big difference.

Analysts at SocGen expect the Fed to announce a $600 billion quantitative easing program (QE3) at this week’s FOMC meeting, according to MarketWatch. An additional $150 billion for Operation Twist is possible at the same time. Here’s what SocGen said:

With economic data signaling stall speed growth for the U.S., we expect the Fed to lower its current 2012 growth outlook from 2.7%, narrowing the gap to our own forecast of 1.8%.

That’s a large drop in GDP growth, and an extension of Operation Twist probably couldn’t do much on its own to turn that around. Thus, QE3.

The only other weapon the Fed has is interest rates, and with those already near zero, that would mean pushing out the low-rate expectation from late 2014 to something even further in the future. That’s possible, but unlikely — even the end of 2014 is still a long ways off and such a move would enrage the Fed’s opponents in an election year.

The most likely outcome from this week’s FOMC meeting does not appear to be a new Operation Twist or QE3, but a more forceful positioning statement that the FOMC could act at its next meeting. That might be enough for this week.

Paul Ausick