Fed considers upping QE3 size and language

After historic changes last month, Federal Reserve officials will meet this week to discuss a possible expansion of the size of its third round of bond buying. However, no final decisions are expected from the Fed and the meeting and is being viewed as less of a cliff hanger after the drama from their meeting back in September.

By Greg Robb
Oct. 22, 2012, 3:03 p.m. EDT
Market Watch

WASHINGTON (MarketWatch) — After historic changes last month, Federal Reserve officials this week will discuss a possible expansion of the size of its third round of bond buying and better ways to guide markets about future policy actions.

At its two-day meeting that starts Tuesday, the Fed may abandon its calendar-date approach to forward guidance and adopt some form of numerical target for policy, according to analysts.

And the central bank will consider whether to expand its bond-buying at the end of the year to take account of Treasury purchases under its Operation Twist plan that finishes at year-end.

No final decisions are expected when the Federal Open Market Committee releases a statement at 2:15 p.m. Eastern on Wednesday. Economists will parse the summary of the Fed’s deliberations to be released on Nov. 15 for clues to what actions may come at the last meeting of the year in mid-December.

After the drama of the central bank’s meeting in September, this week’s meeting is viewed as less of a cliff hanger.

Last month, the Fed announced a plan to purchase $40 billion of mortgage-backed securities per month in an open-ended approach that would continue until the labor market improved.

While it may not sound like much, the Fed may buy over $1 trillion in MBS based on current forecasts, analysts at Capital Economics estimate.

The Fed also took the dramatic step of saying it expects to keep short-term interest rates unchanged even if the recovery strengthens. It also pushed out the calendar date for the expected first rate hike until mid-2015.

There are no pressures on the Fed for immediate action on these two fronts, economists said.

“I think they are reasonably comfortable with the market reaction [to QE3] and the way the economy has turned out,” said Michael Hanson, an economist with Bank of America Merrill Lynch.

Robert DiClemente, chief U.S. economist at Citigroup, noted that, in the wake of QE3, Citi’s financial-conditions index has reached its most accommodative reading since the Fed began easing more than five years ago. “At its current reading, the financial-conditions index is consistent with above-trend growth in final demand, an important prerequisite for stronger hiring and meeting policy goals,” DiClemente wrote in a note.

U.S. Treasury prices drifted lower Monday as traders waited to see if the Fed changes the forward guidance.

“The Fed has entered a holding pattern while watching for signs of a substantial improvement in the labor market,” added Ellen Zentner, senior U.S. economist for Nomura Securities.

At the moment, the Fed is buying $45 billion of long-term Treasurys each month under its Operation Twist program, with the purchases offset by sales of shorter-term securities. Many economists think the Fed will decide to expand QE3 by that amount, and with Treasurys instead of MBS. But the announcement is not expected to come until its December meeting.

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