December 18, 2012
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The following is excerpted from the December 13 edition of “Breakfast with Dave,” a publication from the Canadian research firm Gluskin Sheff:
- The Fed is going to replace Operation Twist, which expires at year-end, with $45 billion of outright buying of Treasury securities (the Fed is also now throwing five-year notes into the mix … and as such the average duration is a tad shorter than it was under the OT program – this could be one reason why the yield curve steepened yesterday). This will boost its balance sheet by that much since there will no longer be any offset from selling short-dated securities. Some pundits thought the mix might have had some incremental buying of mortgages but the wording says long Treasuries (and it is maintaining its $40 billion of agency mortgage purchases per month).
- If there was a new wrinkle, the Fed got rid of mid-2015 with regard to the earliest date the Fed would move away from its zero-interest-rate policy and replaced it with numerical targets, including a 6.5% unemployment rate (though it will look at a broad range of labor-market indicators – a drop in the U-rate premised on an ever-declining participation rate is unlikely to impress the FOMC) and near-term inflation expectations of 2.5% or higher. This overt attempt at not stopping this process of money printing and ultra-low policy rates until it has triggered an increase in inflation expectations that is a half-point higher than the Fed’s target is likely one reason why the back end of the Treasury curve sold off while the gold price rallied as it approached the 50-day moving average in the initial response to the FOMC decision. The DXY index was a casualty.
- On the economy, there were just some modest tweaks. No mention of fiscal uncertainties but Sandy blamed somewhat for the sluggish economy (but the Fed chairman did say in the Q&A session that “fiscal policy becomes very contractionary, I think the economy will go off the cliff”). It did mark up its assessment of unemployment, but it downgraded the consumer. At the margin, the Fed became less tentative in its more positive view on housing, but the bearish tone on business capital spending was left intact. The inflation background was marked down too from “picked up somewhat” on October 24 to “somewhat below the Committee’s longer-run objective.”
At the pace the Fed is going, the funds rate will end 2013 near-zero for the fifth year in a row and the Fed’s balance sheet will expand from $2.8 trillion to $3.8 trillion (it was $800 billion before the QE programs were put into place). So as a share of GDP, the Fed’s balance sheet expands from 18% now to 23% a year from now.
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