September 20, 2011

4 Ways Fed Can Take Action: Stone & McCarthy Report

Downbeat U.S. economy likely will push Fed to keep longer-term rates low, researchers say

Ben Bernanke at a press conference in April. (Photo: AP) Ben Bernanke at a press conference in April. (Photo: AP)

The Federal Reserve’s monetary policy meeting on Tuesday and Wednesday will be “more than usually important,” and the Fed will likely add further stimulus to the U.S. economy, say Stone & McCarthy Research Associates in a report that lays out the policymakers’ four options for taking action this fall.

In a preview of this week’s Federal Open Market Committee (FOMC) meeting, the Stone & McCarthy analysts predict that the September meeting will be “more than usually important.” They note that Fed Chairman Ben Bernanke in a Sept. 8 speech didn’t repeat the FOMC’s options for further easing the money supply. This omission “suggested that the chairman wanted to let markets know that nothing had been decided upon,” says the Princeton, N.J.-based research firm.

The FOMC is expected to announce its decision on Wednesday at about 2:15 p.m. EDT.

Stone & McCarthy researchers see four basic options available to FOMC policymakers, the fourth of which they believe is most likely to happen:

  1. Lowering the interest paid on reserves. “While this is technically possible, we think that the potential for disruption in the money markets makes it the least desirable option,” they say.
  2. Setting an explicit target for a Treasury issue. Talk usually centers on the 10-year note, but 2- or 3-year notes are a possibility. The Fed could set a target yield and then buy securities until it is achieved, but Stone & McCarthy thinks most policymakers would be uncomfortable with open-ended asset purchases.
  • A third round of large scale asset purchases, also known as quantitative easing, could be announced, “but it would have to be quite big, and would add to the already potentially difficult task of reducing an enormous balance sheet,” the researchers say.
  • The average maturity of the Fed’s portfolio of Treasuries could be extended to help keep longer-term rates low. The current maturity of the portfolio averages a little over six years, but if the Fed maintains its current policy of reinvesting maturity securities and prepayments, it would start to buy more of the longer-term issues. Alternatively, the Fed could sell some of its shorter-term securities and buy longer-dated ones, according to the researchers.
  • “If the FOMC elects to provide some further stimulus—and we believe it will—it may be sufficiently unfamiliar in form that markets are going to want to make sure they understand how it is expected to work,” Stone & McCarthy says.

    Read PIMCO’s Gross Warns Fed’s ‘Helicopter Ben’ on Lending at AdvisorOne.com

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