The NFP number was released at 8:30 am. At 8:40 am Goldman Sachs' Jan Hatzius hit "send" on a 356-word email to clients which was checked, vetted, and given the sign off by compliance, in which the Goldman head economist read through the NFP data, and concluded that "Probability of QE3 Next Week Now Above 50%." Curious why the risk assets first dropped then soared as if stung? Because today, once again, good is great, but worse is greater. Let the global liquidity tsunami continue!
BOTTOM LINE: With today’s August employment report showing a nonfarm payroll gain of 96,000 and an unemployment rate of 8.1% because of a drop in the participation rate, we expect a return to unsterilized and probably open-ended asset purchases at the September 12-13 FOMC meeting.
1. We now anticipate that the FOMC will announce a return to unsterilized asset purchases (QE3), mainly agency mortgage-backed securities but potentially including Treasury securities, at its September 12-13 FOMC meeting. We previously forecasted QE3 in December or early 2013. We continue to expect a lengthening of the FOMC’s forward guidance for the first hike in the funds rate from “late 2014” to mid-2015 or beyond.
2. While there is significant uncertainty around the details of any new program, our base case is that QE3 will be formulated as an open-ended asset purchase program of around $50 billion per month, with an end date that is not given in advance but made dependent on progress in the economic recovery. We expect the criteria set for ending the program to be formulated in qualitative terms in the FOMC statement but explained in more detail in Chairman Bernanke’s press conference and in a statement from the New York Fed. We expect Operation Twist 2 to be continued until its scheduled completion at the end of 2012.
3. The return to asset purchases at this time is not a given. It is also possible that Fed officials will limit themselves to a lengthening of the forward guidance. In that case, we believe that they would try hard to find a way to not only lengthen the guidance but make this guidance more powerful by coupling it with a statement to the effect that “…a highly accommodative stance of monetary policy was likely to be maintained even as the recovery progressed.” It is even possible that the committee would adopt Chicago Fed President Evans’ proposal to signal no rate hikes until the unemployment rate has fallen to a specific level (in Evans’ version 7%) unless underlying inflation rises above a specific threshold (in Evans’ version 3%). But that is not our base case.