FOMC to proceed with Operation Twist

Today is all about the end result of the two-day FOMC meeting, which we will learn at 18:15 GMT. Markets have been pricing in a particular sort of monetary policy in recent days and weeks, and it is indeed exactly this policy tool we expect will be announced tonight, namely Operation Twist.



FOMC to launch Operation Twist (again): The policy tool, which was deemed rather ineffective when last attempted in the sixties, is our preferred outcome of tonight's announcement expected at 18:15 GMT alongside a 'no change' in the Fed Funds Rate, which will stay in the range of 0-0.25 percent. As already laid out by our Chief Economist Jakobsen yesterday, the Operation Twist (OT) is an attempt to flatten the yield curve by buying longer-term bonds while selling shorter maturities - without expanding the balance sheet - in an attempt to stimulate borrowing among other things.
We do not look for outright QE3 understood as an enlargement of the Fed's balance sheet such as what we saw with QE2 last year. There appears to be too much opposition to this (at least currently) within the Fed as inflation is rising and bond yields are already very low (UST 10y at 1.954 percent, 30y at 3.223 percent). We expect OT to be announced without a direct target on rates (such as driving the 10y to 1.5 percent) as this would be easily critisised as outright monetisation and would require continual intervention by the Fed.
We do not expect much from OT if indeed implemented. The problem with the US economy is not so simple that it can be solved with lower rates as has been amply demonstrated in recent years. Rather the nature of this recession, a private sector balance sheet recession, means that there is a lack of willing and capable borrowers as consumers instead pay off debt. Lower rates are not the solution and may indeed backfire like QE2 if commodity speculation forces up energy prices and in turn affects consumer demand negatively.
In addition to Operation Twist there is a possibility that the Fed will also lower the rate on excess reserves from 0.25 percent, but we do not view this as having as big a probability as OT. Furthermore, as noted above, this is a balance sheet recession and we are seeing a lack of able borrowers and a lowering of IOER will have little if any impact.

Existing Home Sales to climb in the U.S.? Today's report on Existing Home Sales is not likely to be used for anything except a way to kill time ahead of the FOMC announcement, but for completeness we note that Pending Home Sales have been rather strong in recent months rising 9.3 percent from April to July without a similar strong response in Existing Home Sales. Will it come today? Consensus certainly seems to indicate it will with a 4.75Mln (not thousands as noted in the calendar above) forecast in Existing Home Sales, which seems probable given the strength in Pending Home Sales, though these are a quite volatile time series month-to-month.