FOMC Review: Fed Leaves Door Open for QE3

Last Tuesday, I gave ya’ll a checklist of things to keep an eye on for this week’s FOMC statement. Let’s take a look at that list and see what the Fed had to say about each of those issues.

No Changes to Monetary Policy

As expected, the Fed didn’t make any changes to current monetary policy as it maintained that it would be keeping rates low until late 2014. In addition, the Fed also announced that it would be keeping its asset purchases steady at 600 billion USD.

However, Fed President Ben Bernanke and the rest of the FOMC didn’t completely shut the door on additional quantitative easing measures. In fact, Bernanke said that the Fed was “prepared to do more as needed to make sure the recovery continues” and that bond purchasing is “still very much on the table.”

So yes, QE3 is still very much a possibility!

Revisions in Economic Forecasts

The reason why the Fed voted to put off any additional quantitative easing measures for now is probably due to its increased optimism with regards to the outlook of U.S. economy. As a sign of confidence in the economic recovery, the Fed revised its GDP forecasts for 2012. It now predicts GDP growth to be around 2.4% to 2.9%, up from the 2.2%-2.7% band we saw in January’s prediction.

As expected, the Fed also revised its employment expectations. The unemployment rate is now projected to fall to 7.8% to 8.0% by the end of the year. Earlier in January, the Fed believed that unemployment would be at around 8.2% to 8.5% by year-end.

Bernanke’s Remarks

Once again, Bernanke said that the economy should expand moderately over the next few quarters and even added that it will “pick up gradually.” It was a small change in language that reflected slightly more optimism in the part of the Fed.

However, Bernanke also included that “strains in the global financial markets continue to pose significant downside risk to the economic outlook.” This marked the SIXTH consecutive time that this was included in the FOMC’s statement, indicating the Fed’s concern with the pace of overall economic growth.

To be honest, I wasn’t surprised that sentence was included, given all the hoopla surrounding Spanish bond yields and the recent developments in the Dutch political scene.

Interestingly, Bernanke was also called out on his stance of inflation and his thoughts on allowing the Fed to allow inflation to rise above 2%. According to Bernanke, it would be reckless to aim for a higher inflation rate just to induce a faster reduction in the employment rate. A higher inflation rate would also “erode the central bank’s credibility.”

Clearly, Bernanke is against allowing inflation to heat up and will most likely be keeping an eye on the PCE and CPI reports in coming months.

On Operation Twist

As for Operation Twist, the central bank said that they would continue to swap 400 billion USD worth of short-term debt for long-term debt. The program is also still set to end in June, but Bernanke assured the markets that it doesn’t mean that monetary policy will tighten as well.

EUR/USD Chart

After the FOMC’s statement, the dollar was clearly weaker against the euro. The sell-off wasn’t that bad though as you can see in the chart of EUR/USD. EUR/USD ended the U.S. trading session just 33 pips above its opening price during the Asian session. This reflects the market’s confusion from the statement. While it had a lot of positive points, it did not present any new clues with regards to QE3. It didn’t confirm or deny further QE.

Looking forward, the prospect of QE will continue to cloud the markets and make it difficult for traders to commit to a position. Statements by Fed officials over the next few weeks will be extremely vital, as they may provide us with clues on how they really feel about the economy.