It's All About the Fed and Will It or Won't It

The next Fed meeting is three weeks away, and already the markets have been seriously gaming it.

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Traders expect to see the next set of clues to Fed easing in Tuesday’s 2 p.m. ET release of minutes from the Fed’s March meeting. The street has held a spirited debate about whether the Fed will ease, since just before its March meeting, when Fed Chairman Ben Bernanke testified before Congress that the Fed did not, for now, have to do another round of easing.

His comments were also viewed as more positive on the economy, and traders took him to be less dovish. Interest rates began to rise, and for many in the markets, the Fed’s March 13 meeting statement shortly thereafter confirmed the new belief that the Fed was less likely to do more easing.

But some softish economic data, and new comments from Bernanke last week have sent yields lower, and expectations for easing have risen again. Yet, hawkish Fed members continue to discount the need for another round of quantitative easing , or asset purchases, and they question the Fed’s collective forecast that rates will stay super low through 2014.

“To me, the bar is fairly high for the Fed doing anything,” said Stephen Stanley, chief economist at Pierpont Securities. “The way that I listen to it, even though Bernanke continues to be dovish… but when (St. Louis Fed President James) Bullard, or (Cleveland Fed President Sandra) Pianalto or (Atlanta Fed President Dennis) Lockhart, who are typically middle of the road, those people have all come out and said they don’t see the need for further action right now. So to me it’s kind of dubious they are going to do more.”

It’s another thing for (Dallas Fed President Richard) Fisher to say we don’t need it, or (Philadelphia Fed President Charles) Plosser or (Richmond Fed President Jeffrey) Lacker,” he said.

Goldman Sachs economist Andrew Tilton, however, believes the Fed will do another round of quantitative easing, but he said the markets appear to anticipate a less than 50 percent chance of further easing, or QE3.

“The minutes are clearly going to be of great interest, in part, because of what they say about the likelihood of more QE, and in part because of the likely discussion for different options, and which options seem to be preferred. The minutes will hopefully narrow down what another round of asset purchases would look like, and maybe shed some light on how likely they are to happen,” said Tilton.

The divided Fed splits along the lines of those who see the economic recovery as showing enough signs of sustainability, and those, who like the Fed chairman, emphasize there is reason to worry about deeper problems, like high unemployment. Bernanke, in particular, has warned that removing stimulus too quickly could create another economic relapse, just as the Fed and government officials triggered in 1937.

There is also a concern that federal budget cutbacks could be a serious drag on the economy in 2013, and some Fed watchers say the Fed may want to take action to help the economy ahead of that.

Traders say they are looking to see if the Fed minutes will directly mention “operation twist,” since the program expires at the end of June. Twist is a program where the Fed sells short-dated Treasurys and buys longer duration securities in an effort to keep rates low.

If the Fed decides to do QE3, Fed officials have said it would target mortgage securities, instead of Treasurys as the prior programs have done.

Stanley said he believes the chairman’s comments last week were misunderstood, and he was just defending the Fed’s current positions. “It’s like people take everything he says as if it’s directly related to QE3. So he gave a speech on the labor market which had no direct input on policy but obviously people are reading between the lines that he was trying to signal QE3,” said Stanley.

RBS Treasury strategist John Briggs says he’s not expecting much from the minutes. “The more recent information from the Fed has been dovish. I’m not looking for it (the minutes) to be a major mover,” he said. “They’ll probably talk less about what’s happening now and more about future policy. They’ll be generic and vague... I think the problem is we don’t know what the second quarter is going to bring, and neither do they.”

Tilton said there’s a case to be made for the Fed to announce easing at its next meeting, April 24 and 25, since that is just ahead of the expiration of the twist program.

But the Fed could also wait until its June meeting if there is not enough support for QE because it will get several more important readings on the economy by then.

“The biggest news event, or data point to come before the next Fed meeting, are these minutes and the employment report. Those two things together will have more impact on the market’s assessment of how likely it is,” said Tilton.

The March employment report is released Friday, and economists expect to see the economy again added more than 200,000 jobs. Goldman Sachs economists expect to see 175,000 nonfarm payrolls.

Stanley said he does not expect a clear answer about whether the Fed eases from its minutes, since the Fed is likely to keep to show it is keeping options open.

"I think we’re going to be debating this for the next three weeks, which is going to make for a donnybrook of a meeting in April," said Stanley.

Stanley also said he found it interesting the Fed did not take on the markets when rates started to rise. “When their active policy is twist and the long end (of the bond market) backs up like it did last month, that’s a direct challenge to their credibility, and nobody (Fed officials) really stepped up and said ‘you’ve got it wrong,’” he said.

Besides the Fed minutes Tuesday, there are factory orders, reported at 10 a.m. and monthly car sales, reported throughout the day by auto makers.

San Francisco Fed President John Williams speaks at 4:05 p.m. on the economy to students at the University of San Diego.

Follow Patti Domm on Twitter: @pattidomm

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