Goldman On What To Expect From Tomorrow's Fed Announcement

Tyler Durden's picture

With the expanded two-day FOMC meeting (which until 45 days ago was supposed to be just one day) set to start shortly, here is chief policy maker Goldman Sachs reiterating again how much futile loosening to expect from the Fed. Nothing new here: Goldman repeats its call that Twist will hit tomorrow (and in a following report MS reiterates its call for Torque), sees IOER being cut from 0.25% to 0.1%, (sending the money and repo markets into a tailspin), but stops short of demanding another major round of LSAP. Basically, anything short of this will crash the market; anything long of this (as Rosenberg predicts) including several hundred billion in outright bond purchases, sends risk and gold soaring, and the dollar plunging.

From Goldman: FOMC preview.

  • Although not a done deal, we see a high probability that the FOMC will announce further easing steps at the conclusion of this week’s meeting (September 20-21). The committee put an easing bias in place at the last meeting, and Fed communication—the August FOMC minutes, Chairman Bernanke’s Jackson Hole speech and a number of press reports—has signaled that easing options will be discussed. Moreover, after a two-day meeting, the Fed will be technically prepared to take action.
  • A change in the composition of the Fed’s balance sheet—“Operation Twist”—looks very likely. However, there is still considerable uncertainty about the size and maturity mix of the sales and purchases. As a complementary measure, we also expect that the committee will announce a cut in the interest on excess reserves (IOER) rate to 0.1% from 0.25%, although this is a much closer call. An IOER cut would lower market interest rates a small amount and could aid communication.
  • We see low odds of a change in the Fed’s communication of its policy objectives, a proposal supported by Chicago Fed President Evans and others. This is a complex and somewhat controversial idea, and likely requires further discussion. There also appears to be little appetite on the committee for an outright expansion of the Fed’s balance sheet.
  • The easing tool the Fed used last year—balance sheet expansion—does not look like a realistic option for the upcoming FOMC meeting. The Wall Street Journal reported that this tool “doesn't have strong advocates inside the Fed now”, and otherwise it has been conspicuous by its absence in recent press reports. The Fed may ultimately decide to move in this direction, but we see little chance that this will happen on Wednesday.

Although not a done deal, we see a high probability that the Federal Open Market Committee (FOMC) will announce further easing steps at the conclusion of this week’s meeting. Several factors argue for action now rather than later. First, the FOMC put in place an easing bias at the last meeting when it said it had “discussed the range of policy tools available to promote a stronger economic recovery … and is prepared to employ these tools”. Our research finds that an easing bias at the previous meeting is a strong signal about action at the following meeting (see Sven Jari Stehn, “The Likelihood of Additional Fed Easing.” US Economics Analyst, September 9, 2011). Second, Fed communication—the August FOMC minutes, Chairman Bernanke’s Jackson Hole speech and a number of press reports—has indicated that easing options will be discussed. Third, the Fed will be technically prepared to use most of its remaining tools. Many of the options likely to be discussed have been around for a while—a change in the composition of the balance sheet was debated as far back as 2003, for instance—, the staff has had time to assess these tools further since the August 9 meeting, and the committee will now have two days to finalize details. Our model-based probability of easing at this week’s meeting is 75%, and we would subjectively put the odds even higher.

Measures of core inflation have recently accelerated—the core CPI reached 2.0% year-over-year in August—but we do not believe this will stand in the way of easing at the meeting. Fed officials have made clear that they expect inflation to cool as the effects of a rise in commodity prices and supply-chain disruptions in the auto sector wane. Moreover, wage growth has been soft, survey-based measures of inflation expectations are stable and inflation breakeven rates in the bond market have actually declined (though in part this may reflect “twist” expectations).

Recent press reports have signaled Fed officials are considering three specific easing options:

1. Change in balance sheet composition. This policy option is the single most likely step at this week’s meeting, in our view. It has been dubbed a new “Operation Twist” after a similar Fed program in the 1960s. We believe the Fed will announce outright sales of short-term Treasuries coupled with purchases of longer-term Treasuries in order to lengthen the average maturity of its securities portfolio. Minutes from the August FOMC meeting signaled that active turnover of the balance sheet—sales and purchases—was the option under consideration, rather than the smaller and more passive step of reinvesting ongoing purchases related to MBS reinvestment further out the curve (though this would likely accompany the “twist”). If the FOMC announced only a shift in the maturity of MBS reinvestment flows we would consider it a significantly smaller-than-expected ease.

While an announcement along these lines appears very likely, we still see considerable uncertainty about the precise size and composition of the “twist”. The Fed owns $266bn Treasury notes and bonds that mature before the end of June 2013—over the period during which it has signaled to keep rates exceptionally low—and another $232bn that mature over the following year. We expect the Fed to sell some portion of these holdings—perhaps $300bn or so—and purchase securities with 7 to 30 years remaining maturity (we believe the purchases will likely have the same face value as the sales, even if dollar cost differs, because of the way the Fed has traditionally accounted for its security holdings). The total amount of sales and the maturity composition will determine total amount of duration risk likely to be removed from the private sector. We expect the “twist” to amount to net purchases of $300-400bn 10-year equivalents (i.e. the same amount of duration risk as $300-400bn of the current 10-year note).

For more detail and conceptual background on how the twist could work, see our two earlier articles on this policy option (“For More Easing, Will Fed Go Big or Go Long?” US Daily, August 15, 2011; and “Doing the Twist.” US Daily, September 8, 2011).

2. Cut in interest on excess reserves (IOER) rate. Although it is a much closer call, we also believe the FOMC will announce a cut in the IOER rate—the rate the Fed pays banks for their excess reserve deposits. As discussed in an earlier US Daily, the decision comes down to a cost/benefit calculation, and to date the Fed has implicitly decided that the modest potential benefits from an IOER cut have been outweighed by potential costs and risks. The costs of this option mostly relate to money market functioning: 1) it could impair the normal functioning of the federal funds market; 2) lower rates may interact in perverse ways with deposit insurance fees; and 3) an IOER cut could make it challenging for money market mutual funds to cover their operating costs (for more details, see “Revisiting the Rate on Reserves.” US Daily, September 13, 2011).

Despite several potential costs and/or risks associated with cutting the IOER rate, we believe a majority of the committee could support it. While the benefit in terms of monetary stimulus would be small, it would complement the Fed’s other easing actions—the 2013 commitment language and the “twist”—and could aid communication. Moreover, many of the problems associated with an IOER cut are longer-term in nature. Having signaled that it is likely to keep rates low for at least two years, the Fed may put little weight on these concerns. In order to mitigate some of the associated costs, we believe the committee would cut to 0.1% instead of zero.

3. Change communication about policy objectives. Another policy option that has received increased attention lately would tie the FOMC’s rate commitment language more closely to economic conditions, in order to bring greater clarity to the central bank’s goals and intentions. For example, Chicago Fed President Evans has proposed a commitment to keep the federal funds rate at its current level until the unemployment rate has fallen to 7%-7.5%, provided core inflation does not exceed 3%. The Wall Street Journal reported this morning that Chairman Bernanke has asked Presidents Evans and Plosser and Vice Chair Yellen to explore the idea further, but that “the issue about clarifying goals is unlikely to be resolved at this week's meetings, if at all, because of the wide range of views at the Fed about how to proceed” (“Fed Ponders Jobs, Inflation Targets.” September 19, 2011).

There are some good reasons why the Evans proposal is controversial (“The Evans Proposal to Rebalance the Fed’s Dual Mandate.” US Daily, September 7, 2011). First, it may be perceived as an increase in the Fed's long-term inflation target, which could raise inflation uncertainty and reduce economic efficiency (these were the reasons Chairman Bernanke argued forcefully against lifting the Fed's long-term inflation objective in his 2010 Jackson Hole speech). Second, higher inflation expectations would almost certainly increase the nominal long-term interest rate. In most economic models, growth and other asset prices depend only on real rates, but in practice there are some good reasons to believe that nominal rates matter too. For one thing, many financial institutions assess a borrower's creditworthiness on the basis of their (nominal) debt service-to-income ratio. This metric deteriorates with an increase in nominal interest rates, even if real interest rates are unchanged.


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rocker's picture

Why Bother

Who Cares

He_Who Carried The Sun's picture

Exactly. Until they've all learned to speak Greek, they won't have a clue about what's going to hit anyway!

DormRoom's picture

Uhm.. if you knew someone who was unemployed, or undemployed, and saw the dying of the light in their eyes, you would care.   But to the point, monetary stimulus does not provide jobs.  Fiscal stimulus via direct jobs from the Fed government like the 1920s WPA program does.  But Congress is too dysfunctional to implement what is needed.  So The Fed is using an axe, when Congress should be using a scaple, in policy options.

NeoCapitalist's picture

So you're making the argument that the Fed governmant can and does create jobs, and the WPA and New Deals 1, 2, 3, 4, 5 x 100 worked and were a good idea?  Wow hard to tell you're in "University".. come back and join the big boys if/when you join the real world, or if/when you understand economics. 

DormRoom's picture

you don't need to go back to the New Deal.  You can look at the data after the Japanese bubble burst.  Its economy started to recover once the government started and sustained an adequate amount of fiscal stimulus, supporting aggregate demand, which allowed businesses time to deleverage.  Before then, it was in a vicious deflationary spiral.

LowProfile's picture

Both the New Deal and Japan's intervention stretched the depressions out by decades.

NeoCapitalist's picture

Pretty much my response in a nutshell.. it's not taught that way in the ivory towers, so he cannot see the reality of that statement.  I cannot blame you too much DormRoom, I was once being brainwashed in "University" as you are now... happens to most young men and women in this country. 

NeoCapitalist's picture

And in response to the Japan Asset Bubble, guess you have never heard of the lost decade(s)?

mnevins2's picture

And we can't overlook that Japan's "lost decades" took place while the rest of the global economy was growing strongly.  A fact which is not true today.  Japan is today stuck with a lot of "bridges to no where" and a ton of debt.  FOMC action is the equivalent of sticking the finger in the holes of the dike.  Futile.

Bicycle Repairman's picture

So the choice is a short deep depression or a much longer more moderate depression.

What's that?  In the short deep depression some of TPTB lose their seats at the table?  Oh well f#ck that then!


Irish66's picture

"we believe a majority of the committee could support it"

Thats were we will get the surprise

Roy Bush's picture

Agreed.  And I don't believe this bullshit about "dissenting views" on the Fed Board.  I think the "dissenting views" are there to boost up "inflation expectations".  (They get all hot and sweaty about these terms!)  I think it's one, big, tight group of satanic-worshipping, blow buddies who are fighting over the chance to gobble down the wet cracker.  They will print until the cows come home.  

gjp's picture

I bet they do expand the balance sheet - and Goldman is just setting the stage for a bigger surprise since that's what these puppetmasters think they need to engineer.

That these guys haven't been thoroughly discredited by nowis amazing.  Greenspan is back?  Someone shoot me now, I can't take it.

SheepDog-One's picture

'expand the balance sheet' is now replacement for promised $3 trillion QE3 playmoney printfest for stocks? Anything short of Bernanke uttering 'Im printing $3 trillion' from his quivering lip falls FAR short of what the markets have priced in so far. 

Man I just love this 'lowered expectations' game, freakin insanity....well good luck to all the gamblers who are betting on this crap, I see only disappointment coming. 'Twist'....'LSAT'

equity_momo's picture

A puked a bit of my Cheerios up when i saw good old Alan disappearing into the Fed building right as theyre discussing market moving policy. And he gets paid by Investment banks and Hedge funds in an advisory role. WTF? seriously.

As for all these banks coming out and saying Twist isnt enough and threatening Bernanke with a market sell off if he doesnt pony up with the Opium. Double WTF.   Fuk the lot of them.

Roy Bush's picture

"Expand the balance sheet"....what a joke!  What "balance sheet"!?  What exactly balances?  All liabilities and no assets?  Or, in beautiful logic, is it all assets and no liabilities?  Does conjuring up trillions of dollars aid in passing all standard accounting practices tests? 


Central Bankster's picture

Is it ironic the Ad on the sidebar here is for Lexmark and HP ink printer cartridges?

JohnG's picture

Very.  Office depot ad......

Sambo's picture

If HP gets replaced by Apple at DJIA ...Dow will head north. HP can focus more on selling ink cartridges leaving the tablets for the bigger boys.

Imminent Collapse's picture

No matter what they do, in the long run, gold soars.  Bring it bitchez!

NeoCapitalist's picture

Stimulus = weaker dollar = gold soaring.  No stimulus = market conidtioned to stimulus now becoming scared the markets cannot function without central planners = gold saors.  You're quite right my friend...

King_of_simpletons's picture

EASING == More Vaseline for the sheep.

Sentence: Yo, I want to ease this plunger up your arse.

SheepDog-One's picture

I call bullshit. Now 'QE3' is just a twist, with maybe a LSAT chaser? What was promised was trillions of free play money for stocks since DOW 9,700 back in Feb., WOW talk about lowered expectations!

Lets see how spoiled brat Sweet 16 girl likes her used VW bug unveiled when she was promised a new red Ferrari in front of all her friends. 

This is all such bullshit.

fuu's picture

SD's been on fire all month.

DirtMerchant's picture

I've been waiting for him to stop candy coating all of this and tell us what he really thinks....guess we'll get that version tomorrow...

Tense INDIAN's picture

Gold and Copper are not showing much signs of BIG QE

Troll Magnet's picture

Just get ready to buy a lot more PMs if there's no significant announcement by the Fed.

And if they do announce LSAP, um, just get ready to buy a lot less.

Cdad's picture

I'm so glad that I live in a binary world created by central bankers, who ironically have destroyed finance and world economies.  I love waking up in the morning after a restless night's sleep wondering if the market will be surging or plunging...with the ES lead always smiling at me and telling me everything is alright...until it plunges during the illiquid hours of the Pacific ocean...all depending on what Ben Bernanke says or does not say.

What a great world.  Thank you Ben Bernanke and Goldman Sachs.


Gandalf6900's picture

tomorrow for me is like christmas...I can't wait

SheepDog-One's picture

I think we're going to see quite a show of things un-hinging all over the place!

RunningMan's picture

How is #3 an actual option? Communication is important, but talking about something is different than doing something.  I talk about doing work, but I only get paid to actually do work (when there is work to do, which there isn't). True funding costs need to come down alot to stimulate economic activity, but we simultaneously need a stabilization and reversion of credit risk to norms. We have neither condition satisfied, therefore continued depression. Can the Fed actually fix this? Liquidity trap.


lizzy36's picture

Blah Blah Blah.

Greenspan is attending. Will do a full demonstration on how to properly blow a REAL bubble assisted by Charlie Evans.

Second verse same as the first.


Tyler Durden's picture

So... there will be easing by the Fed in 2011?

Oh regional Indian's picture

Well, there's definitely been a lot of teasing by the Fed in 2011, what's a little T between sheep and master?


SheepDog-One's picture

Right Ori, no shortage of QE 'T'easing a carrot and stick out in front of the markets since DOW 9,800 in Feb. 'T'easing!

sabra1's picture

he's actually there to push his new line of wrinkle remover!

scatterbrains's picture

If twist is priced in what's the harm of nibbling a little on TBT ? Selling the news or better yet a surprise where they abandon twist and ramp the printing press.


disabledvet's picture

Don't worry Mr. Evans. Your annihilation of Chicago will make you a HERO FOR ALL TIME!

spanish inquisition's picture

I will translate recent press reports choices 1. Cook the books 2. Trim some corporate welfare 3. Lie. If you are going to go with the path of least resistance (i.e. easiest solution) the order will be 3-1-2.

The market has priced in infitine ($) Fed support with unlimited backstopping insurance. That is what the Fed needs to do to save itself, it's shareholders and distribution system (Wall Street). I am guessing the last gasp will be here when $10K is sent to every American.

SheepDog-One's picture

Thats really the bottom line, this market has priced in infinite upward move backstopping by the FED, now they have to deliver, and theyre talking about geeky bond rate flipping programs? 

PulauHantu29's picture

This may be the even that sends the yellow metal soaring over $2,000.

How Barbaric!

Quinvarius's picture

I think they will continue to announce nothing while continuing to buy Treasuries hand over fist in whatever timeframes they feel like manipulating.  They have no duty to tell anyone what they do.  So they will only tell their banker buddies how they plan to manipulate things.  The only thing that is certain is that they cannot stop buying US debt.

Tense INDIAN's picture

we have read Rosenberg and Goldaman....but Tyler....ur views on whats coming and what could be the impact ??

Tense INDIAN's picture

we have read Rosenberg and Goldaman....but Tyler....ur views on whats coming and what could be the impact ??

Tense INDIAN's picture

we have read Rosenberg and Goldaman....but Tyler....ur views on whats coming and what could be the impact ??

fdisk's picture

#1 Dollar is "too high" already, this will translates in

lower corporate overseas profits, unless Benrank shoot BIG to

push dollar lower. Twist will not do much, but I don't think

Bernank is ready to full blown QE just yet.