CNBC Fed Survey: Expect a 'Twist' This Week

Markets participants are overwhelmingly banking on the Federal Reserve to deliver a new program to bolster the economy at its meeting this week, according to the latest CNBC Fed Survey.

Traders work in the ten-year U.S. Treasury Note options pit at the Chicago Board of Trade in Chicago, Illinois.
Daniel Acker | Bloomberg | Getty Images
Traders work in the ten-year U.S. Treasury Note options pit at the Chicago Board of Trade in Chicago, Illinois.

Nearly 70 percent of respondents believe the Fed will launch a so-called Operation Twist, in which it buys longer-dated Treasury bonds in an effort to drive down interest rates. And nearly 80 percent of those who took the survey see the program being announced at the Fed’s meeting this week.

The question is whether the Fed is as ready to deliver the new program as the markets believe. If not, the Fed risks disappointing investors, who have priced in additional stimulus. Still, few market participants believe a new Operation Twist will have much impact.

“We don’t believe the Fed has the ability to jump start economic activity. Nevertheless, they will not sit idly by while economic conditions deteriorate,’’ wrote RBC’s Tom Porcelli in response to the survey. (You can take the survey yourself here).

In other findings:

  • The probability of a US recession in the next year rose slightly to 36 percent from 34 percent in the August survey.
  • Survey participants downgraded their outlook for US economic growth to just 1.7 percent this year and 2.24 percent in 2012. That’s down from 2.85 percent forecast in the August survey and the fifth consecutive monthly downgrade for the economy.
  • 57 percent believe that the American Jobs Act proposed by President Obama would lead to “moderate employment gains” while 38 percent see no gains and 5 percent believe it could lead to job losses.
  • 87 percent believe the payroll tax cut proposed by the President will pass, and 80 percent think the tax cut for employers is likely to be adopted. But just 27 percent believe that the additional infrastructure spending proposed in the bill will become law.
  • The chance of a Greek default on its bonds in the next three years increased to 82 percent from 70 percent in the August Survey.

The survey was conducted Sept. 14 and 15 with 59 respondents, including economists, analysts and bond and stock portfolio managers.

While survey respondents expect a new Operation Twist, they have downgraded their chances for additional quantitative easing. Just 34 percent now see a new move by the Fed to expand its balance sheet, down from 46 percent in August.

Among those expecting QE , the average amount expected has come down from $628 billion in August to $527 billion in the September survey. Of those looking for more QE, 70 percent believe it will be enacted at one of this year’s three remaining Fed meetings.

“Expect the Fed to announce additional quantitative easing. This action will scotch the fear trade, tighten credit spreads and send Treasury yields higher,” wrote Chad Morganlander at Stifel Nicolaus.

But Morganlander was in the minority. More participants sided with the sentiments of John Donaldson at Haverford Trust Co., who wrote: “Remember that QE is a tool designed to stave off deflation. We are very far from that risk. Any further QE would serve very little purpose.”

The declining chances for QE were replaced with increasing belief in the market that the Fed would conduct an Operation Twist. On average, participants look for the move to involved about $400 billion worth of bonds.

But participants were mostly critical of such a move. “Twisting the yield curve will do damage to the nation's banks that are best served by a positively sloped curve,” wrote Dennis Gartman. “Hence I think an ‘Operation Twist’ would be detrimental to the banks and thus to the economy; but I fear it may happen anyway.”

A critical question for the markets is in which part of the yield curve the Fed will actually make the bond purchases. Forty percent of participants believe the Fed will concentrate its acquisitions in treasuries in the 5 to 10 year maturity range, and 33 percent see it in the 10 to 15 year range. On average, the market looks for the average Fed purchase of Operation Twist to be 12.5 years, with a median of 10 years.

Whether because of Operation Twist or the weak economy, participants have marked down their outlook for long-term interest rates. The 10-year yield is now seen rising to just 2.25 percent by year end, down from the August consensus of 2.61 percent. By June, the 10-year is forecast to rise to just 2.6 percent, down from a 3 percent forecast in the July survey.

At least for now, market participants have taken a pause in marking down their outlook for the stock market. The S&P is seen ending the year up only 3 percent from current levels, and a 4.5 percent gain in 2012. That’s little changed from the August survey when participants lopped 110 points off their outlook for the S&P this year and next.

Much depends on whether the US enters recession and some participants see the chance being overstated by the market.

“The equity markets are suggesting the odds of a recession are closer to 50 percent versus the actual fundamentals. The actual economic fundamentals suggest the likelihood of a U.S. recession is only roughly 25 percent,” said Stuart Freeman of Wells Fargo Advisors. The company is looking for $106 in S&P earnings next year, a 4.4 percent gain.

But Mark Zandi of Moody’s.Analytics says the fate of the US economy lies in the hands of Athens. “If Greece defaults anytime in the next few months or something worse, the European economy will suffer a severe recession and also drag our economy into the abyss,” Zandi said.