In Depth Analysis: CalculatedRisk Newsletter on Real Estate (Ad Free) Read it here.

Sunday, June 17, 2012

FOMC Preview: QE3 now or later?

by Calculated Risk on 6/17/2012 06:56:00 PM

Some analysts think the FOMC will announce QE3 this week, others think the FOMC will wait until August or September.

It is also possible that the Greek election will influence some FOMC participants to wait until "Operation Twist" ends in a few weeks and then see what happens.

Usually the Fed provides pretty clear signals in advance of additional accommodation, but this time the smoke signals have been a little confused. From Tim Duy: Communications Failure

Reading Cardiff Garcia's preview of next week's Fed meeting, I was struck by [a] chart from Nomura

The extensive discussion of options with arguments for and against reminded me of the fog that hangs over this next meeting. We really have no idea what the Fed is going to do or why they are going to do it. Reasonable analysis ranges from nothing to massive quantitative easing.
Goldman analysts recently put the odds of QE3 this week at 75%, from Goldman economist Sven Jari Stehn on June 8th:
Although the uncertainty is significant, our model points to a probability of easing of 75% at the June meeting. Moreover, financial conditions are critical: were European stress to ease between now and the meeting the estimated probability of easing could drop to around 50%. Conversely, any further tightening in financial conditions from here—such as turmoil surrounding the June 17 Greek election—would push up the likelihood of easing in June.
I think the odds of QE3 are very high, but I'm uncertain on the timing. One key is changes in the FOMC financial projections that will be released this week.  Here are the projections from the April meeting.

The following April chart shows when participants projected the initial increase in the target federal funds rate should occur.

Appropriate Timing of Policy FirmingClick on graph for larger image.

"The shaded bars represent the number of FOMC participants who project that the initial increase in the target federal funds rate (from its current range of 0 to ¼ percent) would appropriately occur in the specified calendar year."

I expect some movement towards later years - and that would be an argument for QE3 this week.

The following table shows the FOMC's projections for GDP. Given the recent weak data, I'd expect the June projections to be lower for 2012 than the April projections.

GDP projections of Federal Reserve Governors and Reserve Bank presidents
Change in Real GDP1201220132014
April 2012 Projections2.4 to 2.92.7 to 3.13.1 to 3.6
January 2012 Projections2.2 to 2.72.8 to 3.23.3 to 4.0
1 Projections of change in real GDP and in inflation are from the fourth quarter of the previous year to the fourth quarter of the year indicated.

It is also likely that the unemployment rate forecast will be unchanged or revised upwards. Currently the FOMC expects the unemployment rate to be in the 7.8% to 8.0% in Q4. Even that level argues for additional accommodation. At the same time, the recent inflation data suggests the FOMC's inflation forecasts will be revised down (or unchanged).

The data suggests the FOMC will announce QE3 soon. But it is hard to tell when, and maybe we will see some clearer signals tonight or tomorrow.