Fed: QE3 is still on the table

Chief Analyst - Johhny Bo JakobsenFederal Reserve chairman Bernanke said Wednesday that further bond purchases by the Fed remain “very much on the table” if the economy needs further support. However, rather than suggesting that more asset purchases are under serious considerations, the chairman confirmed my impression that QE3 will only come into play in the event of serious disappointments on the growth front, especially in the labour market.

Thus it is even more clear now that it will require weak employment reports for both April and May for QE3 to be announced at the June FOMC meeting. But because I still expect economic data to continue to disappoint over the next couple of months I do continue to forecast QE3 in June.

However, I realise it is close to a 50-50 call. It is indeed possible the Fed will decide to end Operation Twist as planned on 30 June without putting QE3 in place. In that case, however, I would expect to see a further sell-off in risky assets and a stronger USD, as seen in the recent past once the Fed ends it easing initiatives (see chart below). Something which eventually could force the Fed to implement QE3 in H2 2012. (I do not agree with those who claim the Fed will be reluctant to introduce QE3 around the election, if needed).

Consistent with a small upgrade of the FOMC participants’ economic projections, including a reduction of the Q4 2012 unemployment forecast to 7.8-8.0% from 8.2-8.5% in January, participants’ forecast of the Fed funds rate took a small step to the hawkish side. Thus, 13 of the 17 participants now expect at least some increase in rates before end-2014, up from 11 in January (see charts below).

However, as Bernanke stressed at the press conference, the participants’ projections of the Fed funds rate do not set the path for rates in stone. These projections serve as input to the discussions, Bernanke said, noting that the committee had no difficulty coming to a consensus that the guidance that “economic conditions…are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014” is still appropriate. It is also worth remembering that of those five FOMC participants who publicly have said they favour a rate increase before 2014, only Richmond Fed president Lacker is a voting member of the committee this year.

Unsurprisingly, the committee also decided to continue the ongoing Maturity Extension Program – Operation Twist.

Risk-off as the Fed takes away the punch bowl

More FOMC participants call for first rate hike in 2014: 13 of the 17 members now expect at least some increase in rates before end-2014, up from 11 in January

Longer out markets are discounting less monetary tightening than even the most dovish FOMC participants expect

FOMC economic projections (central tendencies)
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