Expect Fed to Twist and keep its big guns silent

The outcome of this week's Federal Open Market Committee, (FOMC), meeting, which will be revealed today at 18.30 CET, is rather more difficult to call than most, but my baseline would be for more Operation Twist, (OT), whereby the FED sells short-term Treasuries, (3-yrs maturity), and buys longer term bonds, (10 years, plus).

This will probably disappoint equity markets, which seem to be expecting another 'shot of heroin'.

Why OT, rather than full-blown Quantitative Easing, (QE)?
The most powerful driver for the choice of the less impactful option of OT may be a desire by the Fed to keep its powder dry, given the unquantifiable but possibly enormous hit to growth that could ensue from a disorderly Eurozone disintegration, or even just a disorderly 'Grexit', (at a time which is also indeterminate).

Some form of easing has been reasonably forcibly signalled both by Vice Chair Yellen's June 6th comments...

'...if the Committee were to judge that the recovery is unlikely to proceed at a satisfactory pace (for example, that the forecast entails little or no improvement in the labor market over the next few years), or that the downside risks to the outlook had become sufficiently great, or that inflation appeared to be in danger of declining notably below its 2 percent objective...'

...and by Bernanke utterances last week. The Fed's forecasts, also to be released today, will probably show that at least their growth and unemployment forecasts have fallen - thus fulfilling two of Yellen's criteria for further easing.

QE is much more politically divisive than OT, giving anti-Fed Senators more ammunition to spread scare stories about a Fed that is 'printing money'.

The other political constraint, ie that Fed action too close to a Presidential Election is 'unfair', as easing may favour the incumbent, has probably waned in importance;  the US public is now sufficiently aware of and spooked by the European crisis that they would see Fed action as justified by the debt crisis' threat to growth.

A QE which involved mainly the purchase of Mortgage Backed Securities is an easing option which may be seen as more aggressive than OT but would gain more support from both the public and politicians. Treasury, Fed and mortgage agency officials have often referred to housing as a key headwind to a stronger recovery.

Sterilisation is probable if we get QE

If the Fed did indeed opt for outright purchases of Treasuries via QE, then I think there is also a very good chance that they would announce a 'sterilisation' of the programme, to be achieved by conducting so-called Reverse Repo agreements, wherein the Fed would sell very short-term bills-up to a month in maturity.

Although this is a largely cosmetic exercise, (as the there is no difference in the effect on money supply between this and the increase in bank reserves at the Fed which would ensue from unsterilised QE), it may be presentationally preferable for the Fed and may even have the arguably welcome effect of leading to a smaller increase in public inflation expectations.

With respect to the Fed Funds rate, I would expect the individual FOMC members' forecasts of the date for the first rise in same to move out from an average of 2014 into 2015.