What Do You Expect from the Fed: QE3, Twist or Nothing?


"While the Chairman Bernanke has been non-committal about any action, some other FOMC members seem to be much more willing to act now."

The Federal Reserve's Open Market Committee (FOMC) is meeting today and tomorrow and will decide whether to take additional measures to stimulate the economy.

The Fed has kept the interest rates near zero since late 2008 and it expects the rates to stay at these levels at least through late 2014. Additionally, it has bought more than $2 trillion in bonds to keep the long term interest rates low.

From the minutes of the last FOMC meeting held in April "several members indicated that additional monetary policy accommodation could be necessary if the economic recovery lost momentum or the downside risks to the forecast became great enough."

So what has changed since last meeting?

Labor market data has been very weak of late, suggesting that the recovery has stalled. Recent housing data has been mixed but it is evident that the housing still remains a drag on the economic growth.

The situation in the Euro-zone has clearly worsened and while Greece election results provided some temporary relief, the problems are far from resolved. The slow-down in major emerging economies is now turning out to be much worse-than-expected.

At the same time, the inflation remains near Fed's target of 2%.

And while the Chairman Bernanke has been non-committal about any action, some other FOMC members seem to be much more willing to act now.

So what will the Fed do?

Extend Operation Twist: The Fed's program to extend the maturity of its portfolio (sale of $400 billion of shorter-term Treasury securities and use of proceeds to purchase longer-term securities) is expiring at the end of this month. The aim of the program is to bring down the longer-term interest rates and in turn ease the financial market conditions.

The program did succeed in bringing down the rates, including mortgage rates, which now are at record lows. But not many have benefited from the low interest rates since the banks are not willing to provide credit to any one with less-than-perfect credit.

Announce QE3: Many believe that the Fed would wait until the next meeting (and some more data) before announcing the third round of quantitative easing but that would be close to elections and historically the Fed had avoided any policy action too close to a presidential election.

The market certainly anticipates "some" action from the Fed and may sell-off if the Fed does nothing.

What do you think the Fed will do?

Neena Mishra
Zacks Investment Research

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