Our assumption is that they will change the language of the statement to signal that the balance sheet will remain expanded, and change policy around the MBS program to start reinvesting paydowns." It won't be the last. Should the Fed telegraph further easing, expect stocks to surge at least another 10% as the 10Y approaches 2.5% as nothing makes sense any more.
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Nomura Friday became the first major firm to formally anticipate a change in Fed policy as soon as August 10 to alter course toward some renewed quantitative easing, arguing that without thechange, Fed policy is becoming less accommodative week by week.
"We think there will be something in the (FOMC) language that maybe reverts back to the language of 2009, around the first time they made this statement, that the Federal Reserve needs to maintain an expanded balance sheet," David Resler, chief North American economist for Normura, told Market News International.
"That begs the question, what does that mean to expand," he continued. "We don't think they will actively buy things," he said, but
that they will have to "back up their language."
While the Fed now is committed "only to rolling over guvvies," he said, "they are becoming less accommodative each week. Mortgages are not being replaced" and other shrinkage is taking place.
"They need to have a strategy for preserving (the balance sheet's) size. Does that mean they will reinvest paydowns. I don't know, and we're agnostic on how they will do it."
Just lowering rates "is not on the table any more," he said, and changing the rate of interest on excess reserves "is the last option they would resort to." At present "they are losing assets, so I think they would not want to lose them."
Getting into the practical implementation issue, "do they offset dollar for dollar every prepay they at the time they get it?" Resler asked. "They may not be able to do that."
In any event, the change in language, while having its own effect, won't be enough. There will have to be activity, he said.
Resler and colleague George Goncalves have dubbed whatever is to be done "QE light," with a risk of other actions, such as cutting the rate on excess reserves.
Overall, the Fed must do something because of the deterioration in the data since March and the downward revision in the Federal Open Market Committee's outlook, Resler said. Nomura does not see another recession, but a sufficient case based on economic performance for some manner of easing.
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