FOMC extended Operation Twist until the end of 2012, and is ready to launch QE3 if labour market conditions do not improve.
As expected, The FOMC has announced new monetary stimulus, through the extension of Operation Twist (OT2) and of the reinvestment policy for principal and coupons of agency debt and MBS until the end of 2012. ….
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While the economic outlook is still consistent with a moderate recovery, employment growth has slowed, and the unemployment rate remains high, as opposed to a more optimistic assessment of the labour market in April. This was the difference prompting the change in the FOMC’s stance and its decision to act. Otherwise, the assessment of aggregate demand and prices changed very little. As expected, macroeconomic projections were revised downwards, rather sharply over the 2012-2013 horizon (see below). Projections of official rates were left unchanged, and the statement confirmed that rates will probably remain exceptionally low “at least through late 2014”, as previously indicated.
The maturity-extension programme will be continued until the end of 2012, two quarters beyond the original expiration date. The Fed will purchase securities with a residual life of between 6 and 30 years, while selling an equal amount of securities maturing between 0 and 3 years, at the same pace adopted since OT was put in place. Also, the policy of reinvesting coupons and principal payments from its holdings of agency debt and MBS will continue. Reinvestment of Treasuries, instead, will be halted. The extension of OT will generate sales and purchases around 267 billion dollars by the end of 2012. Purchases will be distributed as illustrated in the Table below, barring changes dictated by market conditions. At the end of each month, the NY Fed will continue to publish an tentative calendar for the following month. On average, securities will be bought and sold each month for a total of around 44 billion dollars.
The FOMC statement concludes with the commitment that the Fed is prepared to take further action as appropriate to promote a stronger economic recovery and “sustained improvement in labour market conditions”. The Fed will continue to monitor the adjustment of the labour market, and the June decision will allow the central bank to assess political and fiscal policy developments in the autumn, and to prepare effective actions in case of need.
During his press conference, Bernanke reasserted the Fed’s commitment to contribute to a rebalancing of the labour market, signalling that against a background of forecast inflation below the 2% target, the Fed will set policy by focusing on growth and employment. Bernanke said that the Fed “still has ammunition”, and “if we don’t see further improvement in the labor market, we will be prepared to take additional steps”. Labour market adjustment and overall growth prospects will remain the most reliable compass to forecast the course of US monetary policy in the next quarters. A worsening of labour market conditions may call for additional intervention even before the end of OT2. This message will contain any potential appreciation of the dollar, even in the face of the euro crisis, and keep long-term yields close to current levels. Finally, we know that the Fed is worried about incomplete transmission of monetary policy from Treasury yields to risk assets and mortgage rates. Any instances of a deterioration of the economic picture would trigger purchases of securities other than Treasuries.
As for the OT2 effects, analyses conducted by the Fed and the BIS show that on average the QE and OT programmes have shifted the yield curve downwards by around 15-20bps. The effects on real rates, though, are reduced by slower expected inflation. The announcement of a round of QE3 is possible in the autumn, in our view.
Appendix
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