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While the economy is expected to get over the hump in 2013, the Federal Reserve is likely to continue purchases of Treasuries and agency mortgage-backed securities past market projections.
The market is expecting an end to the open-ended third round of quantitative easing in mid-to-late 2013, but Goldman Sachs expects the program to continue through 2014, indicating QE3 will eventually turn into QE4.
Click on the chart to view Fed securities holdings.
The Federal Open Market Committee minutes for December reveal the Federal Reserve is likely to slow monthly purchases of $85 billion in mortgage bonds and Treasuries sometime in 2013.
While there was a clear majority in favor of further asset purchases beyond the Maturity Extension Program, the timing of completion of such purchases received mixed results.
The FOMC announced rates will remain unchanged with continued purchases of additional agency mortgage-backed securities at a pace of $40 billion per month.
"Taken together, these actions should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative," the Fed said.
There are two reasons Goldman Sachs remains dovish on Fed policy: higher than desired unemployment and low inflation.
Fed officials said they would not hike up interest rates as long as the unemployment rate stays above 6.5%, which is likely to happen through late 2015.
Other analysts expect a more rapid fall in the unemployment rate and some doubt that officials will follow through on the guidance provided. However, Goldman Sachs believes the Fed will stick to its word.
Lower inflation is also expected to stay below the 2% target.
During the past six months, the core personal consumption expenditures price index rose at a 1% annualized rate, which is under Goldman Sach's projection of 1.5% growth.
However, Fed officials may be contemplating an even more aggressive approach than assumed, Goldman said.
"This is evident from simulations by Vice Chair Janet Yellen that use the Fed staff’s large-scale econometric model, FRB/US, to generate an 'optimal control' path for monetary policy. We believe that market participants have so far failed to grasp the full implications of Yellen’s approach," the report noted.
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