At the end of its two-day meeting on Wednesday the Federal Reserve will put out one of the more anticipated and unusual statements in its history. According to Deutsche Bank’s Chief U.S. Economist Joe LaVorgna, here’s how it may read:
“To help support the economic recovery in a context of price stability, the Committee decided today to increase the size of the Federal Reserve’s balance sheet further by purchasing up to an additional $50 to 100 billion per month in longer-term Treasury securities for a maximum amount up to $500 billion over the next six months. At that time, the Committee would be prepared to provide additional accommodation if needed to support the economic recovery and to return inflation, over time, to levels consistent with its mandate. In considering possible further actions, the FOMC will take account of incoming information about the economic outlook and financial conditions. The Committee also will maintain its existing policy of reinvesting principal payments from its securities holdings.”
Many investors believe the Fed will go a dovish step further than that by not giving a time frame or a maximum amount of Treasury purchases, but rather a per-month amount or an initial figure of $500 billion with a pledge of more to come as needed.
“It would be best to give a total without a timeframe, but then keep the second part very open ended with an emphasis on reacting to market conditions as they see fit,” said Pete Najarian, co-founder of TradeMonster.com and a ‘Fast Money’ trader.
The S&P 500 is up more than 15 percent from its 2010 low on July 2nd. That was right around the time when speculation began to grow that Fed Chairman Ben Bernanke would embark on a second round of direct Treasury purchases, or quantitative easing, to keep interest rates low and put more liquidity into an ailing economy headed toward a double-dip.
Some economists began to put their estimates of the total amount of quantitative easing at, or above, $1 trillion, adding fuel to the rally. The enthusiasm waned a bit this week after a Wall Street Journal article suggested the Fed will use a more “measured approach,” announcing a program of purchases “worth a few hundred billion dollars over several months.”
If the Fed were to take a more hawkish approach, it could cool the animal spirits further. Deutsche Bank’s LaVorgna sees a stronger statement reading something like this:
“To help support the economic recovery in a context of price stability, the Committee decided today to increase the size of the Federal Reserve’s balance sheet further by purchasing up to an additional $125 billion of longer-term Treasury securities before the next regularly scheduled FOMC meeting on December 14. The Committee is prepared to provide additional accommodation if needed to support the economic recovery and to return inflation, over time, to levels consistent with its mandate. In considering possible further actions, the FOMC will take account of incoming information about the economic outlook and financial conditions. The Committee also will maintain its existing policy of reinvesting principal payments from its securities holdings.”
“It would not be a surprise to me to hear a more hawkish tone in the rhetoric,” said Jim Iuorio, a trader with TJM Institutional Services. “At this point, however, they can’t back off the ‘QE’ intentions for fear of a market shock. Expect a more hawkish tone, but still dovish actions."
On August 10th, the Federal Open Market Committee confirmed that they had more up their sleeve by saying they would reinvest principal payments from the agency debt and mortgage-backed securities they bought during the credit crisis into longer-term Treasuries. An initial move that was intended to have the same effect of additional quantitative easing, but keep the central bank’s balance sheet at the same level.
But in its last post-meeting statement, the Fed signaled it was clearly fearful that its action to date had not done enough to ward off deflation, Bernanke’s biggest fear throughout this crisis.
“Measures of underlying inflation are currently at levels somewhat below those the Committee judges most consistent, over the longer run, with its mandate to promote maximum employment and price stability,” said the September 21st statement.
Next week, the Fed could lift the language from its first quantitative easing involving Treasury purchases communicated on April 20, 2009:
“The Federal Reserve will buy up to $300 billion of Treasury securities by autumn. The Committee will continue to evaluate the timing and overall amounts of its purchases of securities in light of the evolving economic outlook and conditions in financial markets.”
The S&P 500 climbed more than 20 percent from the day before this statement to September 23, 2009, when the Fed said that it would be ending its purchases “by the end of October 2009.” Stocks continued to rise after that, but eventually would fall back to October 2009 levels this July.
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Traders don’t want to risk that for the second round. “They will keep it open and won’t even say $500 billion,” said Michael Block, chief equities strategist at Phoenix Partners Group. “Keeping it open is very positive.”
Just how open-ended is the big question. Joe Saluzzi, a partner with Themis Trading jokingly submitted this ideal statement:
To help support our $1.7 trillion portfolio of MBS securities, the Committee decided today to double down and take on even more risk on the Federal Reserve’s balance sheet by purchasing a bunch of Treasury securities. The Committee is prepared to provide additional accommodation if needed to support our balance sheet and take on the risk of inflation even though that is against our dual mandate. We realize that we are walking a tight rope here and the risk of creating inflation with no real economic demand is probably not a good idea, but heck, we have no other options. The Committee would like to remind the American public that our actions are not without precedent. Lehman and Bear Stearns also embarked on similar highly levered, risky strategy with other people’s money in the recent past.
In considering possible further actions, the FOMC is announcing today that on the completion of QE2, we will immediately begin QE3 and soon after announce the initiation of QE4.
That’s traders for you. Always thinking one step ahead.
* For the best market insight, catch 'Fast Money' each night at 5pm ET, and the ‘Halftime Report’ each afternoon at 12:30 ET on CNBC.
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