The Federal Reserve is unlikely to initiate another round of quantitative easing – or the purchase of assets like mortgage-backed securities – but it could respond to a lagging economy by extending its Operation Twist initiative, economist Paul Dales with Capital Economics said Tuesday.
"Unless the economy loses a lot more momentum or the eventual financial contagion from the crisis in Europe is much greater than we expect, the Fed is unlikely to launch a third round of asset purchases," Dales wrote. "However, the Fed may respond to the weaker tone of the incoming data by announcing a short extension to its Operation Twist program at next week's FOMC meeting."
Dales said if the Fed does expand Operation Twist, which would include the Fed utilizing proceeds from the sale of $400 billion in short-term securities to buy long-term securities, it would let the Fed address slower growth, giving it more time to see if the economy can pick up speed again without QE3.
Right now, the Fed has enough short-term treasuries left to extend Operation Twist for another six months, but not beyond that point, according to Dales.
The launch of QE3 is more unlikely, but still possible, he added.
"If hopes of QE3 are to become a reality, either the economy would need to lose a lot more momentum, core inflation would need to fall well below the 2% target, or the downside risks to growth from the crisis in Europe and the looming fiscal cliff at home would need to rise significantly," Dales explained. "While our forecasts don’t include any of these eventualities, the most plausible are a further near- term easing in jobs growth and/or greater financial contagion than we expect from Greece ditching the euro. In that regard, how the markets react to the Greek election on June 17th could be crucial."