Expectations ramp up for QE3 — but maybe not now

Fed watchers have little doubt the central bank is getting ready to launch what’s commonly called “QE3,” or a new large-scale asset purchase plan, but many think the countdown will be placed on hold until later this year.

“We don’t think the most likely outcome [in September] is going to be the announcement of another large scale asset-purchase plan. I am not convinced they are ready for it,” said Lewis Alexander, chief U.S. economist at Nomura Holdings.

“FOMC members continue to struggle with the appropriate structure for a future QE,” agreed Ward McCarthy, chief financial economist at Jefferies.

If this is the case, analysts said, headlines from the two-day meeting that ends Thursday will come from a less-aggressive step of altering language on a low-rate pledge. This will likely be extended until mid-2015. The current Fed pledge is to keep rates at “exceptionally low levels” through at least late 2014.

Also, the central bankers will try to put a more positive spin on the guidance by stressing that a longer period of interest rates close to zero is not a sign that the economy is going to be flat on its back for three more years, said Lou Crandall, chief economist at Wrightson ICAP.

Federal Reserve Chairman Ben Bernanke will try to stress that the central bank will keep rates low even as the economy recovers. A key paper presented at the Jackson Hole conference suggested that the demand-boosting effect from the extended guidance may be offset by pessimistic forecasts. Read more about the Fed guidance study.

Further, many analysts do think the Fed will launch a new program to snap up more Treasury bonds or buying mortgage-backed securities issued by the likes of Fannie Mae and Freddie Mac.

Jim Glassman, economist at J.P. Morgan Chase, said he thinks the bond market “has high odds” on asset purchases. But if it doesn’t happen, “they will expect to hear it is still on,” he said.

The Fed has already purchased $2.3 trillion of Treasury and MBS in two rounds of QE. The Fed is now running an Operation Twist program to replace $400 billion of short-term debt with longer-term securities.

Crandall said he expects the Fed to announce a QE3 program to purchase close to $100 billion in assets per month. The Fed is already buying $75 billion per month in Operation Twist and reinvestment operations, he noted.

Glassman’s opinion appear to be spot on with regards to how market has been reacting to FOMC and Bernanke’s decisions/statements. Market has been reacting kindly to Bernanke’s lack of action. You can see the latest 5 times market has reacted to Fed’s action (or rather inaction).

via – MarketWatch

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