Fed Does the Least
In the past few days, news outlets have breathlessly reported that the Federal Reserve would today launch into another round of quantitative easing, probably including major purchases of mortgage backed securities. Instead, the Fed did the least that was expected, extending Operation Twist until the end of the year, but not altering the size of its balance sheet at all and not – as some analysts suggested it might – changing when it thinks it will start raising rates (still late 2014).

Operation Twist was originally implemented last September and has the Fed selling short-term Treasury securities and using the proceeds to buy long-term Treasury securities. We don't think this program makes a dime's worth of difference for the economy. In the end, it's really an act of fiscal policy, not monetary policy, no different than if the US Treasury Department financed the federal debt by issuing more short-term debt and issuing less long-term debt. (By the way, given very low long-term interest rates, this would be an awful idea.)

Compared to the last statement from April 25, the Fed did make some changes to its language, all in the dovish direction. The Fed said "growth in employment has slowed," "household spending appears to be rising at a somewhat slower pace," and unemployment looks likely to decline "slowly," rather than "gradually." It also said inflation "has declined."

In addition, the Fed made it clear that it "is prepared to take further action" if either the situation in Europe deteriorates or the labor market fails to improve.

These changes are consistent with the new economic and interest rate forecast from the Fed. The Fed now projects real GDP growth of 1.9% to 2.4% in 2012, a downgrade from April, when the range was 2.4% to 2.9%. The Fed also reduced its estimate for growth in 2013, to roughly 2.5%, and projects unemployment will still be 7.5% to 8% at the end of 2013. Previously, the Fed was more confident the jobless rate would be down to 7.5% by that point in time. The Fed also slightly reduced its estimate of inflation for 2012.

While the Fed still projects near zero short-term interest rates through the end of 2014, the median forecast among members of the Federal Open Market Committee is that the funds rate will end 2014 at 0.5%, not the 1% previously forecast. In addition, the range for the federal funds rate over the long term fell slightly. It's now 3% to 4.5%, but used to be 3.5% to 4.5%.

Once again, the lone dissent from the Fed's statement was from Richmond Fed President Jeffrey Lacker, who opposed the extension of Operation Twist.

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Posted on Wednesday, June 20, 2012 @ 2:15 PM

These posts were prepared by First Trust Advisors L.P., and reflect the current opinion of the authors. They are based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements expressed are subject to change without notice. This information does not constitute a solicitation or an offer to buy or sell any security.