As we head for the fateful FOMC announcement on September 18, US data have continued to moderate. Accordingly, the consensus seems to be converging on a $10-15 billion initial reduction in monthly purchases (mostly focused on the Treasury side and less so on MBS) with any ‘tightening’ talk tempered by exaggerated forward-guidance discussions and the potential to drop thresholds to appear more easy for longer, since as CS notes, assuming Fed policymakers have learned anything in the last four months, they must know that the markets view “tapering” as “tightening,” even though they themselves for the most part do not. Thus, they are going to need to sugar-coat the message of tapering somehow. But as UBS notes, political risks have grown and there is little clarity on the Fed’s thinking about the housing market. This leaves 3 crucial surprise scenarios for the FOMC “Taper” outcome.
As Exhibit 4 indicates, we expect a $20bn taper in September, evenly split between MBS and Treasury purchases. Our baseline scenario includes another couple of $20bn taper moves in early 2014, at the January and April FOMC meetings, with a final $25bn cut at the June meeting to end the program around mid-year.
If our scenario holds, QE3 will have totaled just over $1.3 trillion, more than double QE2’s $600bn and a few hundred billion short of QE1, which expanded the Fed’s balance sheet by $1.725tn. Under these assumptions, the balance sheet will be nearly 50% larger by mid-2014 than it was when QE3 commenced in September 2012.
We have drafted an imaginary press release that embodies many of the ideas discussed above. Also, in the interest of shortening and simplifying the FOMC statement, we changed some of the arguably superfluous language that has been employed by the Committee over the past few meetings. As a consequence, Exhibit 6 below is one part forecast, and one part recommendation: