Operation Twist with open-ended mini-QE - 09/14/2012

Key Alerts:

• FOMC launches more QE with an expiry date conditional on labour-market improvement.
• This conditional expiry date is a major change from previous QE announcements Fed combines 

The Federal Reserve has decided to err on the aggressively dovish side, introducing a fresh round of stimulus and threatening more if the situation warrants it. This is a clear sign that the FOMC is comfortable with the inflation risks of its action and is very frustrated with the slow decline in the jobless rate. The post-meeting Statement says that the Fed will buy USD 40bn of Mortgage Backed Securities (MBS) in addition to the USD 45bn worth of US Treasuries (UST) under Operation Twist currently being conducted each month between now and year-end. On its own, this round of quantitative easing (QE3) appears to be a smaller version of QE1 and QE2. However, the new MBS purchases will be continued, increased or combined with additional easing programs should the labour market fail to improve “substantially”. This is a very dovish departure from previous rounds of QE, giving no particular expiry date.

The key is now defining “substantial”. We expect 150,000 additional net monthly hires through end-2012 and 170,000 from 2013. This will mean only slow progress in bringing the unemployment rate down given that the number of new entrants to the job market each month is around 100,000. 

Unemployment currently stands at 8.1%; we look for guidance from the FOMC as to a suitable target, as the FOMC forecasts do not look for 7% to be breached until end-2014. The announcement was accompanied by the extension of the commitment to exceptionally low rates through at least mid-2015.