MacroScope

By almost all accounts, the Federal Reserve is expected to “stay the course” on its massive bond-buying program after next week’s policy-setting meeting. That would mean a continuation of the $85 billion/month in total purchases of longer-term securities, probably consisting of $40 billion in mortgage bonds and another $45 billion in Treasuries. Laurence Meyer of Macroeconomic Advisers is one of countless forecasters predicting this, calling it the “status quo.”

Problem is, the U.S. central bank’s current policy is not simply to buy $85 billion in bonds — and if it does announce such a program on Wednesday, it should probably be interpreted as policy easing, not a continuation of current policy.

The $45 billion in longer-term Treasuries is part of a program called Operation Twist that offsets those purchases with $45 billion in sales of shorter term Treasuries. In June, Fed policymakers extended Twist to the end of the year, meaning the market — which rallies each time the Fed eases policy — should have priced in an end to the $45 billion shuffle in the Fed’s portfolio of assets. It also means that there is really only $40 billion in outright bond-buying happening today, as part of the Fed’s third round of quantitative easing (QE3). Not $85 billion.

From that perspective, the market is expecting a pretty substantial boost in policy accommodation next week, but not calling it easing.

James Bullard, president of the St. Louis Fed bank, tried to make this point in Little Rock, Arkansas this week: “If the goal is to keep policy on its present course, the replacement rate should be less than one-for-one,” said Bullard, who will have a vote on monetary policy next year. He floated $25 billion in Treasury purchases, instead of $45 billion, as a level that would still give the economy enough of a boost while lowering the risk of inflation. Philadelphia Fed President Charles Plosser has said flat out that it would be wrong to think of the end of Twist as policy tightening.

1. Since the second phase of Operation Twist just got underway, “it would be strange to announce outright purchases of Treasury securities.” 2. Fed officials have publicly noted that continued purchases of long-term Treasury securities “might compromise the functioning of the Treasury market — and undermine the intended effects of the policy.” 3. San Francisco Fed President John Williams “directly advocated” mortgage purchases and Fed Vice Chair Janet Yellen has said that “beyond the Twist extension, ‘it’s more likely that [the FOMC] would do things that would take a different form.’” 4. “Purchases of mortgage-backed securities may be considered less controversial than Treasury bond purchases amidst the charged political environment, just prior to the presidential election.”