What To Expect In Tomorrow’s Fed Decision
Today’s the big day. It’s when the markets finally find out if the US Federal Reserve will be willing enough to pass another round of monetary stimulus. So, what options does the Fed have? Not much. But, although it’s more of the same, what the central bank will put to work will be a different twist this time around.
The most likely scenario of additional monetary stimulus will involve another round of treasury bond and note buying. And, given the effectiveness of past rounds of fixed income and asset purchasing, it’s no wonder central bankers will likely choose this route. But, there will likely be a major change in the manner in which the Fed will conduct these operations. More specifically, how the purchases are accounted for. Previously, policymakers would extend the maturities of its overall balance sheet by revinvesting purchases down through the curve. But, now, the Federal Reserve would look to make outright sales and purchases – selling short term maturities and buying up longer term ones.
This will likely involve about $300 billion in stimulus, covering medium term to longer term securities – making the average maturity a little over 10 years.
Fed officials may also toy with a more detailed structure on the future of long term monetary policy. This would be a follow up to the board’s last meeting where central bankers promised low rates for an extended period of time. This time around, policymakers may make defined and conditional terms when it comes to the end of loose monetary stimulus – whether through a lower rate of unemployment or higher rate of gross domestic product. The only problem with this scenario, is caused by the diversity in US central banking views – decreasing the probability of this event happening.
A lastly scenario could be the Interest On Excess Reserves or IOER - a rate offered by the Federal Reserve paid to banks for their reserve holdings. This type of move would increase the likelihood that bank reserves are used in more higher yielding situations (housing and small business loans), rather than lower yielding Fed rates. But, let’s be honest, the likelihood of this event is slim. Not only will dissenters on the FOMC bar the actual passage of this option – as three members did last time around – there are monetary problems that may arise from such a decision. The lower rate could compress earnings spreads for commercial banks as well as causing a shake up in the money markets.
So, with little in the way of new measures, the Federal Reserve is likely to implement some newer versions of some old tricks. But, the only downside risk in tomorrow’s release could be the fact that the Fed does too little. With most of the stimulus expectations already priced into the market, asset classes across the board could experience a sharp selloff if the US central bank fails to appear without a plan.