Wednesday, October 24, 2012

October 23-24 FOMC Report

Martin B. McGuire

The heavy lifting, so to speak, was accomplished at the September 12-13 FOMC meeting as noted, ‘…the Committee agreed today to increase policy accommodation by purchasing additional agency mortgage-backed securities at a pace of $40 billion per month.’   To further help support a more immediate return toward ‘trend’ growth the committee acknowledged it would not execute future policy decisions solely on the basis of a forward-only view.  Instead it noted, ‘…the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens.’    

While it remains a ‘soft’ promise to refrain from raising policy rates until well after respectable growth is evidenced, the pace and direction of communication on this topic should help us to understand some lasting nature to this commitment.  This commitment too may well be strengthened to include some numeric guideposts for unemployment and inflation.  I suspect however the Fed will wait for a later date to announce any such plans. 

In my September FOMC report I held; ‘It is my belief therefore that there are very strong odds we shall receive an announcement for additional LSAP (QE3) at this September FOMC meeting…’ and ‘…if announced LSAP measures are forthcoming, we should further expect the Fed to announce an extension of the policy guidance. To announce QE3 without extending guidance presents the risk that QE3 alone will be found insufficient to lower long-term yields.’ 

It is now widely expected that the Fed will include Treasury securities in its monthly purchasing plans.  I would agree with this forecast but see reason to expect this announcement to come after the October FOMC meeting.  Just as the Fed had combined the announcement of open-ended agency mortgage-backed securities purchases plans with changes in forward guidance communication at the September FOMC meeting, we should expect the same formula to accompany the announcement of addition of Treasury security purchases in December.  As the Fed is likely to need additional time for discussing stronger guidance language before a consensus can be reached, we should expect both the announcement of additional Treasury purchases and changes to guidance language to wait until December.  

Those who remained concerned the Fed was not doing enough to support growth and employment should have been satisfied by the actions initiated and the guidance offered at the September FOMC meeting.  It is clearer to me now the Fed has the votes to move forward through 2013 with a very accommodative mandate which leaves little doubt they should succeed in finding ‘trend’ growth as sustainable by early 2015.  With this expectation in mind and earlier noted commitment to maintain an over accommodative stance through mid-2015, I am urging clients to give careful consideration to the prospects for the monetary policy stance active in late 2015. 

Since the Fed started to use its balance sheet to affect monetary policy I have advised we expect the securities purchased to remain with the Fed for a very long time.  It is conceivable the majority of these securities purchased actually mature from the Fed’s portfolio.  The notion of the Fed holding a majority of current and future additions to the balance sheet to maturity is not widely accepted but has attracted a few more fans since QE1.  At a minimum, I expect that when the time comes the Fed will find some strategic opportunities to sell from its portfolio.  However, they should not be expected to use portfolio sales as a monetary policy tool per se.    

To the extent one believes the market will price the Fed as holding to maturity even a large minority of Fed portfolio assets, one must also be willing to adjust expectations for future appropriate policy fed funds rate as this policy tool will be expected to carry more than its usual load.


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