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Fed Now More Likely to Do Third Round of Easing: Pros

QE3 may be coming after all.

In a dramatic turnabout, market participants now believe the Federal Reserve is more likely than not to resume purchasing assets during the next year in a third round of quantitative easingthe August CNBC Fed Survey shows.

Ben Bernanke
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Ben Bernanke

"There is no doubt that over the last week the odds of seeing another round of asset purchases has risen significantly ," says Tom Porcelli, chief US economist at RBC Capital Markets. "This doesn’t mean we think it will have any more success than QE2. What this simply reflects is a Fedwith few remaining options. "

Meanwhile, the 60 respondents—who include economists, stock and bond strategists and portfolio managers—disagree with the S&P decision to lower the US credit rating from Triple-A to Double-A plus.

Fully 70 percent of market participants gave the US the top Triple-A rating, a higher percentage than France and the UK, which are rated Triple-A.

In other survey findings:

  • Participants believe there is now a one-in-three chance that the US enters recession in the next 12 months.
  • The outlook for the federal funds rate—which the Fed uses to influence other short-term interest rates—was lowered to just 0.25 percent by the end of next year, down from a one percent forecast in the July survey.
  • Stocks will rise strongly from the current low levels, but are not seen regaining the highs of this year anytime soon.
  • 57% say the bigger threat to the US is cutting government spending too quickly rather than not getting the deficit under control quickly enough.

After the Fed’s promise this week to keep interest rates lowuntil mid-2013, 46 percent of respondents said the Fed will resume QE, up from 19 percent in the July survey; 37 percent said the Fed will not do QE, compared with 68 percent in July.

Of those who believe the Fed will resume QE, the asset purchases are expected to average average for $628 billion, up from $377 billion in July.

Mike Deuker of Russell Investments predicts: "Look for the Fed to initiate QE3 if the 10-year Treasury yield lingers below 2.25 percent, which is a sign of Japan disease. "

Three regional Fed presidents dissented from the decision to keep rates low, but market participants were in greater agreement with the Fed chairman. The move is supported by 70 percent of respondents, with 20 percent disapproving and 12 percent neutral. (Totals don’t add to 100 percent due to rounding.)

Chris Rupkey of Bank of Tokyo-Mitsubishi called it "just an empty promise." But he added: "Broken promises aren't always a bad thing. Fed policy is still conditional on the economy... Once the crisis passes, the economy will pick up and the Fed will alter its promise."

David Goerz of Highmark Capital said: "The Fed's mandate of price stability will trump any ability to promise low rates until 2013. Inflationof two to three percent is already becoming entrenched and loose monetary policy risks even higher inflation that could become increasing difficult to contain."

Most respondents want the Fed to keep going. Fully 88 percent think the Fed should do more than just pledge to keep rates low. Just under half want the Fed to increase the maturity of its portfolio and 27 percent said the Fed should buy assets other than Treasurys, such as mortgages.

Goerz said: "The Fed should consider lowering the interest rate it pays on bank reserves long before even contemplating QE3."

But John Kattar of Eastern Investment Advisors said we'll likely get one or the other in just two weeks: "At Jackson Hole, we will either see another large scale asset purchase, or a reduction or elimination of the interest rate paid on free reserves at the Fed. "

In fact, while 52 percent said Fed policy is “just right” (the same as last month), 12 percent say the Fed isn’t loose enough, compared with just 3 percent in July.

Responding amid the market turmoil of August 9 and 10, participants sharply marked down their forecasts for the stock market and Treasury yields. The S&P is now seen reaching only 1252 by year-end. In July, the participants predicted the S&P would hit 1364 by year end. Participants also lowered their outlook for June 2012 to 1310 from 1421.

By year-end, the 10-year Treasury yieldis seen at 2.61 percent, compared with an average forecast of 3.41 percent in the July survey. In June 2012, the 10-year bond is seen yielding just under 3 percent, 75 basis points lower than forecast in the July survey.

In terms of fixing the US economy, 31 percent favored additional government stimulus, but 25 percent opposed it and 44 percent were neutral.

Wells Fargo's Mark Vitner said: "I would be in favor of additional fiscal stimulus if I thought it could be done well. I do not have much confidence today, however. "

But 57 percent said the biggest danger to the US economy is cutting government spending too quickly while 43 percent said the bigger threat is not getting the deficit under control quickly enough.

Still, participants gave the US the top Triple-A rating, scoring an average just below Germany but equal to Canada, which are both rated Triple-A by S&P. The US had a higher score than France and the United Kingdom, which are also rated Triple-A.

Participants put the chance of a US default at just 2 percent in the next three years, down from 4 percent in the July survey. And they dialed back the chance of default for Greece to 70 percent from 83 percent and for Portugal to 45 percent from 52 percent.

Here are the complete results from our survey, including comments from some of the participants:

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