Posted on September - 20 - 2010
US FOMC: QEII moving closer
Details
The FOMC statement left the language in the growth section broadly unchanged compared to August although surprisingly the committee chose to highlight the current low level of inflation, declaring it to be “below the Fed’s mandate to promote maximum employment and price stability”.
Further, a direct reference to possible further quantitative easing was included in the last paragraph of the statement, stating that the Fed is “prepared to provide additional
accommodation to support the economic recovery and to return inflation, over time, to a level consistent with its mandate”.
Key takeaways from these two changes to the statement are as follows:
(a) QEII is moving closer; if the economy fails to recover soon (i.e. over the next 2- 3 months) the Fed will pursue large-scale asset purchases; and
(b) Bernanke, in his Jackson Hole conference speech highlighted that there are costs attached to QE, mainly the risk of increased inflation expectations. However, with the statement emphasising the low level of inflation, this cost is probably regarded as very limited at present. This clearly reduces the threshold for initiating a large-scale treasury purchase programme.
Finally, we think it worth noting that Hoenig dissented again. He voted against both the decision to keep the ‘extended period’ language and the decision to continue to reinvest the principal payments from the Agency and MBS outlook.
Assessment and outlook
Whether the Fed will eventually introduce further QE is a close call, although today’s statement has increased the probability of it doing so. If economic data fail to recover in coming months, the next step from the Fed will be to do so, probably through large scale purchases of treasuries. Given the dovish twist in today’s statement combined with our expectation that inflation is likely to trend lower and data remain mixed over the next couple of months, the balance has moved more in favour of additional QE.
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