Marc Chandler, of Brown Brothers Harriman & Co., recently added to the ever-expanding lexicon used to describe the U.S. Federal Reserve’s policy arsenal: “Twist2.”
His attempt at neology was inspired by the wordsmiths who introduced QE2, Wall Street’s shorthand for the Fed’s second go at quantitative easing in late 2010, and QE3, the nickname for a third bond-buying program that many analysts believe will be prompted by either the European debt crisis or the deteriorating economic recovery in the United States.
Twist2 is a riff on the original Operation Twist, the moniker for the Fed’s September decision to lower longer-term interest rates by selling from its stockpile of short-term assets, using the proceeds to buy bonds with maturities of six to 30 years.
The monetary twist is back in vogue because the $400-billion (U.S.) program is scheduled to conclude at the end of the month. Not so long ago, that seemed fine. But as the Fed’s policy makers gather for a two-day meeting starting Tuesday, it’s starting to look like the Federal Open Market Committee (FOMC) could opt to extend the program, hence Mr. Chandler’s Twist2.
The U.S. economy has slowed considerably from the 3-per-cent annual growth rate it reached in the fourth quarter. Growth in the first quarter was 1.9 per cent, according to the Commerce Department’s most recent estimate. That’s not fast enough to lower the unemployment rate, which rose to 8.2 per cent in May, from 8.1 per cent in April, as employers added a mere 69,000 jobs, the weakest in a year.
The Fed considers a jobless rate of about 5.5 per cent to be in line with its mandate to achieve “maximum” employment.
“If we were part of the FOMC, we would be voting for providing more support to the economy,” Paul-André Pinsonnault, an economist at Montreal-based National Bank Financial, said in a research note. He predicts U.S. gross domestic product will expand only 1.8 per cent between the first quarter of 2012 and the first three months of 2013.
According to Kevin Logan, chief U.S. economist at HSBC in New York, U.S. GDP growth will decelerate further in the second quarter, to an annual rate of about 1.2 per cent. For the year, he says the U.S. economy will do well to grow by 2 per cent.
Most FOMC officials were predicting growth of between 2.4 per cent and 2.9 per cent in April, the last time they made forecasts. Policy makers will finalize new outlooks this week, which will determine the Fed’s next steps.
Two weeks ago, Fed chairman Ben Bernanke told lawmakers in testimony on Capitol Hill that it likely will take economic growth of at least “trend” to lower the unemployment rate. That translates to an annual rate of roughly 2.5 per cent. The implication of his comment is that if the FOMC decides the economy lacks momentum to reach that rate, policy makers likely will step on the accelerator.
Analysts at Morgan Stanley in New York say there is an 80-per-cent chance the FOMC will vote to adopt new stimulus measures this week. But they are less certain on what steps the Fed will take.
Some predict QE3, which would see the Fed create hundreds of billions of dollars to buy financial assets. While a few members of the FOMC clearly favour that course, most are more cautious. As long as their forecasts show at least moderate economic growth, it seems likely the Fed will wait to see whether the labour market’s dismal showing in May was an anomaly.
More probable is Twist2, Mr. Chandler’s bet. Analysts at Capital Economics point out that the Fed has only about $200-billion of assets left in its vault with which to twist, making an extension little more than a symbolic gesture.
With the situation in Europe unsettled, and the economic outlook unclear, a relatively uncontroversial move that buys a little time could be the Fed’s preferred course.