March 16th FOMC "Extended period" or not?

Discussion in 'Trading' started by Dogfish, Mar 16, 2010.

  1. Dogfish


    Will they take it out or leave it in?

    The FOMC will convene for their 6-weekly meeting on monetary policy and publish its
    statement at 19.15 CET. In January, the FOMC statement didn’t contain too many
    surprises. The Fed upgraded its eco outlook and unwound its emergency policy
    measures further, but confirmed its intention to keep rates very low for an extended
    period of time. The dissent of Kansas Fed Hoenig certainly was a surprise. The
    statement said: “Voting against the policy action was Thomas M. Hoenig, who believed
    that economic and financial conditions had changed sufficiently that the expectation
    of exceptionally low levels of the federal funds rate for an extended period was
    no longer warranted.” The Minutes of the January FOMC specified that Hoenig was
    looking for more policy flexibility by not retaining the extended period of time language
    and suggesting the phrase that rates would be low for some time.

    Another regional FOMC voter, St-Louis Fed Bullard later on showed overtly sympathy
    for the view of Hoenig and while less clearly also governors Lockhart and Evans
    seem to favour a change in the wording to give the Fed more flexibility going forward.
    Against these voices, most other governors seemed still comfortable by keeping this
    language in the statement. So, the debate on the language of the forward-looking
    rate guidance will be central at the FOMC meeting. We think there is a real
    chance that it will be changed or at least to appease hawks and doves a compromise
    is found to change it at the April 27-28 meeting. The January FOMC
    Minutes showed large divergences on the issue of potential asset sales. Most participants
    judged a future program of gradual asset sales could be helpful in shrinking
    the size of the balance sheet and interestingly, several thought it important to begin
    the program in the near future and shrink the balance more quickly than could be
    achieved by solely redeeming maturing securities.

    No decisions were taken though. In the mean time, officials of the influential NY Fed
    suggested that the Fed shouldn’t actively sell the assets it purchased as an emergency
    support measure during the crisis. Maturing assets wouldn’t be replaced,
    shrinking the pool of assets gradually. We think that the Washington-based Board is
    of the same opinion, contrary to a number of regional Fed presidents who want to
    start selling assets quite fast. We think that the NY Fed opinion will prevail. Selling
    assets might unsettle the mortgage market that is still very weak. The question of
    selling assets is not a theoretical one. Indeed, if the Fed doesn’t sell assets, it will
    have to conduct its policy via its rates (FF, interest paid on excess reserves). If
    it does sell assets, the tightening will happen via the longer end of the curve,
    allowing the Fed to keep official rates very low for longer. The Fed asset purchase
    programme nears completion (end of March) and given the uncertainty surrounding
    it, we don’t expect the Fed to add to the uncertainty by introducing the perspective
    of asset sales.

    Concluding, a change in the wording of the FOMC statement might be a further step
    in the normalization of policy. It gives the Fed more flexibility and keeps the outlook
    on rate hikes in H2 alive, on condition that the economy improves further and the recovery
    becomes broad-based and self-supportive. If the change does occur, we expect
    the money market and the short end of the bond market to correct, flattening the
    bond curve. There have already been some moves towards a faster tightening in recent
    weeks. The implied Dec FF rate stands at 0.53% currently versus 0.44% at the
    start of the month.