Questions hover over Fed buying of Treasury debt
By Pedro Nicolaci da Costa |
October 28, 2010, Thursday
|
Print Edition
Print Edition
THE Federal Reserve looks set to embark on a hotly debated second round of monetary easing next week, but much uncertainty surrounds the scope and pace of bond purchases by the United States central bank.
Market expectations have centered around an initial commitment to buy at least US$500 billion in Treasury debt over five months in an effort to spur lending and support an economic recovery that is too weak to tame high unemployment.
Further muddying the outlook, Fed officials have offered conflicting signals on their policy predilections in recent weeks, with some pushing for a very aggressive stimulus and others highly skeptical of any additional accommodation.
This makes it harder to gauge where the ultimate consensus will settle, though most analysts assume Fed Chairman Ben Bernanke's dovish leanings will carry the day.
Here are some ways in which next week's decision might play out:
This is the base-case scenario for financial markets - investors may have already priced in even more, in fact. However, any disappointment at the headline figure would likely be more than offset by any nod to the possibility of further purchases if conditions warrant. That would be interpreted as an open-ended promise to do whatever it takes to ensure the recovery is on track and spark rallies in US stocks and government bonds. The dollar, which has been gaining ground this month, would suffer.
The Bernanke-led Fed has shown a propensity for erring on the side of going big. This is based on the notion that policy acts with a lag, and that fighting inflation is easier than battling deflation. The Fed could choose to go beyond market expectations in order to build in an extra "announcement effect," in the same way that intermeeting rate cuts are believed to offer more bang for the buck. This would lead to a sharp rally in riskier assets like stocks and emerging market bonds. Commodities would also rise sharply as investors worry about the possibility of an unruly dollar decline.
Given opposition within the Federal Open Market Committee from hawks, it is not inconceivable that the Fed will find it hard to settle on a large upfront commitment.
Market expectations have centered around an initial commitment to buy at least US$500 billion in Treasury debt over five months in an effort to spur lending and support an economic recovery that is too weak to tame high unemployment.
Further muddying the outlook, Fed officials have offered conflicting signals on their policy predilections in recent weeks, with some pushing for a very aggressive stimulus and others highly skeptical of any additional accommodation.
This makes it harder to gauge where the ultimate consensus will settle, though most analysts assume Fed Chairman Ben Bernanke's dovish leanings will carry the day.
Here are some ways in which next week's decision might play out:
This is the base-case scenario for financial markets - investors may have already priced in even more, in fact. However, any disappointment at the headline figure would likely be more than offset by any nod to the possibility of further purchases if conditions warrant. That would be interpreted as an open-ended promise to do whatever it takes to ensure the recovery is on track and spark rallies in US stocks and government bonds. The dollar, which has been gaining ground this month, would suffer.
The Bernanke-led Fed has shown a propensity for erring on the side of going big. This is based on the notion that policy acts with a lag, and that fighting inflation is easier than battling deflation. The Fed could choose to go beyond market expectations in order to build in an extra "announcement effect," in the same way that intermeeting rate cuts are believed to offer more bang for the buck. This would lead to a sharp rally in riskier assets like stocks and emerging market bonds. Commodities would also rise sharply as investors worry about the possibility of an unruly dollar decline.
Given opposition within the Federal Open Market Committee from hawks, it is not inconceivable that the Fed will find it hard to settle on a large upfront commitment.
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