You can consider this a preview of both next week’s meeting and the one in September, as various reports have indicated that he Fed may wish to wait for more economic data before deciding what to do next.
As usual we won’t play the percentages; instead we’ll just run through the possibilities and list a few of the potential complicating factors involved with each of them.
1) QE3
– Would it take the shape of new Treasury purchases, agency MBS, or some combination of the two? And how big will it be?
– The last presser, the FOMC minutes to the June meeting, and Bernanke’s recent semi-annual testimony to Congress all revealed that the FOMC is more worried than usual about the potential for additional asset purchases to cause financial market disruptions. But the specific worries remain vague.
– One possible issue with respect to further Treasury purchases is that liquidity for auctions of the longer-end securities has behaved erratically and fallen in recent months (and already had been even prior to the Fed’s renewing Operation Twist in June):
And surely that weird July auction of 10-years when the direct bidding was unusually high (though it now appears to have been the result of bidding by a single, non-primary dealer) didn’t help.
– As for MBS purchases, there are several concerns as well, though we find MBS purchases at least as likely as Treasury purchases if the Fed does QE3. One worry is that actual mortgage borrowing rates are unlikely to follow MBS rates down. Another is low net supply of these securities and relatedly, as we explained earlier, MBS settlement fails tend to increase as the Fed builds up its holdings of them.
– John Williams discussed the idea of an “open-ended” QE with Robin Harding several days ago. It seems to us that the same worries as above about impeding market functioning with excessive asset purchases would apply here, but we’re not sure how many other FOMC members favour this approach.
2) Reduce or eliminate interest on excess reserves
– We think this is a problematic idea.
– Bernanke has previously rejected it, and we doubt he’ll change his mind, but who knows.
3) Change the “rates exceptionally low” language from late-2014 to sometime in 2015
– There is little obvious cost to doing this.
– The main hindrance to its effectiveness is that Bernanke will be gone by January 2014 and the future voting membership won’t be as pliant, meaning that it can be changed again later and thereby limiting the credibility of such a change.
– Or… Bernanke could emphasise again that he views the two per cent inflation target as symmetric, not as an effective ceiling. If he wants take this line of thinking further, he could say that the Fed would be willing to allow inflation to run over the target for a temporary period of time (or even temporarily change the target) while unemployment came down. In light of Bernanke’s previous comments on the issue, we find this unlikely.
4) Using the discount window to give banks cheap funding conditional on its being used to make loans
– The model for this is the UK’s recently announced Funding for Lending scheme
– Banks are already awash in liquidity and funding could hardly be cheaper; why would they need this? More to the point, how would this help?
– The logistics of setting this up would take some time, plus there’s the issue of the Fed’s becoming semi-involved in credit allocation, traditionally not its thing. (We find the latter less of a problem than the former.)
5) Alter Operation Twist
– This could mean either slowing its pace in combination with another measure or perhaps simply ending the front-end sales.
– There continue to be worries about the fact the Fed has a dwindling supply of short-end Treasuries to sell, so this would make a certain amount of sense.
– That said, we haven’t actually seen this idea reported or even floated anywhere.
6) Other communications changes
– As Robin noted when the minutes to the June meeting were released, the FOMC is exploring the possibility of constructing “a quantitative economic projection and associated path of appropriate policy that reflected the collective judgment of the Committee”. In other words, a consensus forecast rather than the bubble chart showing each individual (anonymous) Fed member’s forecast. This would be more probable at the September meeting, when the Fed updates its Statement of Economic Projections.
Related links:
The academics on QE – FT Alphaville
QE3, the market functioning fear factor – FT Alphaville
Show some real audacity at the Fed – FT
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