The Federal Open Market Committee (FOMC) started its two-day meeting today. The result of the Greek elections delayed the need to move immediately to shore up liquidity in global markets and launch another round of quantitative easing. Concerns about both Europe and recent slackening in the U.S. economy, however, will remain front and center in what are likely to be heated internal debates.
The lowest-hanging fruit is an extension of “Operation Twist,” which would provide some support for both the mortgage and Treasury markets. The impact on Treasury yields will remain overshadowed by uncertainty in Europe and the flight to safety that has accompanied it, but extending the twist is nonetheless important as a tool to signal the Federal Reserve’s ongoing support of easy monetary policy in such a weak, economic environment.
The Fed will also be releasing revisions to its forecasts, which will no doubt be weaker than we saw last time around. Some around the table will be inclined to shift out the date when the Fed expects to raise rates, from late 2014 to 2015, in response to those forecast changes. One has to start wondering about the credibility of the Fed’s communications policy, however, given the uncertainty over such a long horizon and the risk that a new Fed Chairman may not agree with such a policy. Chairman Ben Bernanke’s term as Fed Chair expires in early 2014. If Republican presidential candidate Mitt Romney wins, Bernanke’s replacement could be someone who has been extremely vocal in criticism of his policies. John Taylor, in particular, has written many op-ed pieces criticizing current monetary policy and is considered a top contender to replace Bernanke under a Republican administration.
Bottom Line: The Fed has been in constant contact with its counterparts the world over, and has grown increasingly worried about containing a crisis should another one erupt. Our banks and firms are better positioned to weather another financial crisis than they were in 2008. However, that threshold is not hard to clear. Moreover, we clearly have fewer policy tools to combat a panic, if one should erupt, which means that the Fed is likely to keep what little powder it has left dry.