This Week's FOMC Meeting: Why to Expect More Stimulus

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Investors should expect welcome news from the U.S. Federal Reserve Wednesday at the end of this week's two-day FOMC meeting.

As central bankers gathered Tuesday for the last policy meeting of the year, expectations were high that Fed Chief Ben Bernanke and his cohorts will announce a large scale asset purchase plan to replace the soon-to-end Operation Twist, introduced in September 2011.

The Fed hopes additional stimulus will finally boost growth and the employment level. With the current unemployment level at an elevated 7.7% — a number that economists say will be revised higher in the coming weeks – the weak labor market remains a grave concern.

At recent meetings, the Fed indicated that it will continue QE3, the policy of buying $45 billion in mortgage-backed securities each month until it sees a significant and sustained improvement in the employment scene – which is unlikely to come anytime soon.

Together with Operation Twist, the two programs added some $85 billion in long-term bonds to the Fed's balance sheet each month.

The aim, the Fed said in a statement, "should put downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative."

The central bank has also stressed it would employ its other policy tools "if the labor market does not improve substantially."

While the Fed did not elaborate on what those tools are, it maintains it still has plenty of ammo left and stands ready to pull the trigger when and if necessary.

It looks like now is the time.

Three Things to Watch at this Week's FOMC Meeting

  • QE4?

With Operation Twist ending on Dec. 31, and the lingering anxiety of falling off the fiscal cliff intimidating in the background, the Fed is unlikely to let a major amount of stimulus disappear, especially if Congressional lawmakers can't hammer out a deal by year's end. So more stimulus is expected and it could set the Fed's policy tone for 2013.

Analysts suppose the Fed will continue to buy $45 billion per month of long-dated Treasuries. But, this time around, this will be done without the simultaneous selling of short-term ones as has been the case under Operation Twist.

The future of the $45 billion per month Treasury purchases are expected to be open-ended as well (not swapped for short-term ones), and has prompted a handful of astute economists to give the new policy the name QE4, the Business Insider reports. It will also swell the Fed's already swollen stash.

"QE4 will result in a doubling of the expansion rate of the Fed's balance sheet," UBS economist Drew Matus notes.

As for the maturity of the bond purchases, economists say they could include bonds with maturities as short as four-and-a-half years, so as to include the five-year notes. Under Operation Twist, the maturities were in the 6-30 year range.

  • Language and Projections

The Fed has pledged to keep interest rates at near zero levels until at least 2015. That is not expected to change.

There is not much lower for rates to drop. And besides, skeptics argue the low rates have done little to help the economy. So bringing them down even lower won't have a noteworthy impact.

Plus, the Fed has vowed not to raise interest rates until the unemployment level dips to 6.5%.

What are expected to change are the economic projections.

Societe Generale economist Aneta Markowska notes the Fed's "2013 GDP forecast published in September still looks relatively high at 2.5%-3% and is at risk of being revised lower."

Yet most economists don't see much in the way of forecast revisions given the uncertainties surrounding the economy.

  • Fiscal Cliff Factor

Bernanke cautioned last month that if the economy fell off a "broad fiscal cliff" whatever the Fed could and would do, it wouldn't be enough to offset the aftershocks.

Should the $607 billion wallop from higher taxes and government spending cuts kick-in on Jan. 1 and endure for a good part of 2013, any good from the Fed's assets purchases, low stance on interest rates and loose monetary policy will not prevent an imminent recession next year.

So even if the Fed can cushion the fall, it can't stop the country from tumbling over the cliff. That is up to Congress.

The outcome of this week's FOMC meeting will be announced Wednesday at 12:30 p.m.

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  1. John | December 11, 2012

    We are screwed.

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