Given recent indications that the U.S. economic slowdown has become more pronounced recently, the markets will be scouring the minutes of the June 19-20 Federal Open Market Committee meeting, due to be published on Wednesday, for signs that the recently announced extension to the Operation Twist program is just another step along a path leading to a fresh expansion of the central bank's balance sheet through new asset purchases, known as QE3.
We expect the minutes to have a generally dovish tone, albeit with a wide range of opinions expressed, Michelle Meyer, and the economics team at Bank of America Merrill Lynch, wrote in a note to clients.
Market participants will be looking for any general agreement on the conditions that would justify further easing, as well as a discussion of the costs and benefits of various tools.
Paul Ashworth, chief U.S. economist at capital economics, projects the minutes will reveal that the FOMC deliberately left the door open to more action. He suggests the notes may show that the number of members who believe that more asset purchases may be needed has grown from the smaller group of 'several' members -- which is Fed-speak for four -- who had suggested additional stimulus could become necessary at April's meeting.
At the end of its two-day meeting in June, the FOMC offered a bleaker picture of the U.S. economy than it had at its prior gathering in April. Officials cut forecasts for U.S. growth in 2012 to a range of 1.9 percent to 2.4 percent, from between 2.4 percent and 2.9 percent.
The Fed also maintained its assessment that exceptionally low interest rates would remain necessary until at least the end of 2014. Fed officials raised their estimate for the unemployment rate in the last three months of this year to a range of 8 percent to 8.2 percent from between 7.8 and 8 percent.
Fed Chairman Ben Bernanke said the central bank was ready to ease monetary policy further if needed.
We are prepared to do what's necessary. We are prepared to provide support for the economy, Bernanke said at a post-FOMC press conference. Additional asset purchases would be among the things that we would certainly consider if we need to take additional measures to strengthen the economy.
The minutes, generally released three weeks after the date of the policy decision, will provide information about what led participants to downgrade the outlook and whether the downgrade was a function of the two new voters -- Jerome Powell and Jeremy Stein -- or a broader-based downgrading by many participants.
On the forecasts, economists are looking for in-depth comments on the risks to the outlook as well as any debate about the long-run trend growth rate, as the central tendency shifted slightly lower at the June meeting.
Additional discussion on refining the Fed's communication strategy is also expected.
They will talk about communications strategy, but I'm not sure that it would be that big a deal, ITG Investment Chief Economist Steve Blitz said. Personally, I think over-communication doesn't necessarily bring more clarity.
QE3 Is Around The Corner
Only a few weeks after extending until year-end a program that would sell or roll over $267 billion of short-term holdings into longer-term Treasuries, Wall Street economists in recent days have become more convinced than ever that the Fed will embark on QE3.
A Reuters poll on Friday revealed that primary dealers, the large financial institutions that deal directly with the Fed, expect a 70 percent chance that the $2.3 trillion QE program will be expanded.
Michael S. Hanson, U.S. economist at Bank of America Merrill Lynch, views the extension of Operation Twist as a down-payment on further easing.
He and his team expect the Fed to launch a $500 billion QE3, likely concentrated on mortgages, in September, and to push out its forward guidance to mid-2015 by August or September.
Importantly, the Fed is expected to react to economic conditions and not the political calendar.
If the Fed needs to do something, either easing or tightening, they will do it, Blitz said. They are not shy about doing what's necessary around elections.
Recent speeches made by Fed officials have also helped stoke QE3 expectations.
We're really right at that edge, if economic data continue to come in below expectations and if our view is that we don't expect to make progress on our mandate, then I would think we need more accommodation, Federal Reserve Bank of San Francisco President John Williams said in remarks in Idaho Monday. He is a voting member of the interest-rate setting FOMC.
Chicago Fed President Charles Evans, who doesn't currently hold a voting role on the FOMC voting roster, echoed Williams' concern in comments made before the Sasin Bangkok Forum in Thailand.
Because the U.S. isn't making clear and steady progress toward stronger growth, Evans said, I support using our balance sheet to provide additional accommodation.
QE3 Has Its Limits
The minutes will almost certainly state that any additional action would depend on the evolution of the incoming data. In that sense, the plunge in the ISM manufacturing index in June and the subdued 80,000 gain in payroll employment in the same month have increased the chances of QE3.
That said, the data have not been weak enough to make QE3 anything like a done deal. Much will depend on the gross domestic product (GDP) report for the second quarter, which includes the benchmark revisions for the previous year, and July's ISM index. Both will be released just days ahead of the Fed's next policy meeting, which concludes on August 1.
Even if QE3 does set sail, some hold that pumping up the market further would only prove to be counterproductive, and a third attempt at QE may well miss the mark.
One reason is because people are still unloading the burdens of the millennial debt bubble. Low interest rates and easy money won't necessarily prompt them to borrow more or to spend more.
The minutes will show that the big question debated by the FOMC members is whether or not the monetary policy has reached its limit of effectiveness in helping to boost the economy, Blitz said. That honest disagreement is what I'm most interested in reading about.