The FOMC Statement: A Litle Closer But Not There Yet

The FOMC statement this afternoon (http://www.federalreserve.gov/newsevents/press/monetary/20100921a.htm) contained a little bit for everyone. To those who have been increasingly agitating for another meaningful round of quantitative easing, the statement offered the seemingly reassuring language that the Committee" will continue to monitor the economic outlook and financial developments and is prepared to provide additional accommodation if needed". At the same time, there was not even an attempt to present the contours of the criteria that will be used to make that determination, an omission that reveals traces of ambivalence, or unpreparedness, within the FOMC about such action.

The Fed's hesitation to be more specific, or assertive in its intention to implement additional quantitative easing is probably the result of both its natural reluctance to promise, or commit to, a specific outcome but also the product of its continuing soul-searching as to where that route makes fully sense on a risk-reward basis. For an additional round of material quantitative easing, an increase in the size of the Fed's portfolio by a number in the vicinity of $1 trillion is probably what the Fed is looking at, with no guarantee that such an injection will actually be pivotal in jump starting the anemic recovery. At the same time, by taking that route, the Fed will be dramatically increasing the magnitude of its own headaches in handling successfully the exit strategy when the time ultimately comes (because, at some point, it will!). The issue of whether creating that substantial additional risk that will be left lurking around the corner is a worthwhile endeavor for the Fed is arguably unsettled in the policymakers' own mind at this point.

A reasonable conclusion, based on the above, would be that additional quantitative easing of some significance is not yet a done deal, particularly in view of some publicly expressed resistance to such measures by some Fed officials. However, the Treasury market's nearly euphoric reaction to the announcement strongly suggests that the consensus interpretation is that it is only a matter of time until the Fed proceeds with such action- it is as if the "when" is the only issue to be settled and no longer the "if".

This is a risky proposition. By adopting that interpretation, the market is exposing itself to the prospect that the tone of the various economic reports stabilizes in the coming weeks (signs of which have actually appeared recently) and this provides the Fed with more breathing space to wait longer before any decision about more quantitative easing is put in place. The odds that such action will in the end be taken have risen somewhat in the wake of the FOMC's statement today, but they are not nearly as close to a foregone conclusion as today's price action in the Treasury market implies.

Anthony Karydakis