Viewpoint: Our forecast is that a purchase programme will be announced in September

Lug 27, 2012

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QE3 likely to be announced by mid-September. In a week that is dense with central bank meetings (ECB, BoE and Fed), the Fed should act by tweaking communication,…….

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while providing tangible signals of the activation of more substantial measures by the September meeting.

– At the meeting of 31 July-1st August, the FOMC should continue to move gradually, offering another taste of monetary stimulus via a change in communication and groundwork ahead of QE3, which will probably be implemented in September. Mounting tensions on the European markets, and persistently poor US economic data, support forecasts for the opening of a securities purchase programme soon. While Chairman Bernanke’s testimonies did not go into detail, they clearly signalled the Fed’s intention to intervene in the presence of two conditions:

the domestic labour market’s failure to reabsorb slack, and a heightening of risks at the international level. Both these conditions are materialising. The likely action revolves around three tools: 1) communication; 2) QE3 with MBS purchases; 3) credit easing programs.

– Our forecast is that a purchase programme will be announced in September: the “open” format suggested by Williams (see below) could be a concrete option, if accompanied by transparent conditions on the objectives guiding the Fed’s decisions. In August, the expected date of the initial Fed Fund rate hike should be pushed back, to at least 2015 (from “late 2014” at present), and indication of more concrete action with QE3 coming soon should be clear.

There is considerably more uncertainty over the third type of instrument, i.e. a credit easing programme, aimed at impacting credit conditions in lending to the private sector. On this front, during his testimony Bernanke mentioned the possibility of using the Fed’s discount window to supply funds to banks which step up lending to households and companies, along the lines of the programme just activated by the Bank of England. To a programme of this kind, the Fed could add a reduction of the current discount rate from its present level (0.75%). We believe the rate on deposits is unlikely to be cut to zero, given the sceptical or negative views expressed in the past by the FOMC on such a measure. One factor which in favour of credit easing already in August could be that the Fed’s balance sheet would not be expanded definitively, leaving a decision on QE3 until September, when more monthly data will be available and the end of Operation Twist will be in sight.

– Following Bernanke’s testimonies before Congress, explicit indications of decisive action have emerged. Among the many voices, the words of S. Bloom Raskin (Board) were especially indicative: Raskin rarely makes public statements, she does not side with either end of the opinion range, contrary for instance to Yellen, and probably represents the stance of the FOMC centre. Raskin said that at the next FOMC meeting a new securities purchase programme will probably be discussed. Recently Rosengren, Pianalto, Lockhart, Evans have spoken out in favour of bond purchases. Williams (San Francisco) stated that the only cons are the uncertain effects of the measures and the cost/benefit ratios of further actions. His view is that MBS purchases would me more effective and have smaller side effects on the functioning of the market, as opposed to Treasuries purchase programmes. According to Williams, it may be best to announce an “open” programme, with no preset expiration and/or amounts, to be implemented flexibly depending on the development of the economic situation.

– As for QE3, it is around the corner, in our view, and the Fed is weighing the pros and cons of various options. Which securities could be purchased without creating distortions on the market? The margin for purchases at the long end of the Treasury curve is now very limited.
The Fed has already purchased around 31% of outstanding securities with 2021 maturity and the share will increase further as Operation Twist proceeds. The extension announced in June provides for 32% of purchases on the 8-10Y segment, corresponding to around 85 billion dollars. Given the risks of a progressive drop in the market’s liquidity, combined with the aim of achieving a more direct easing of credit terms on lending to households, the next purchase programme may be concentrated on MBS. In August the FOMC could signal that a new programme is being drawn up, to be announced soon if conditions justify its adoption.

Appendix

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