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Morgan Stanley continues to think the Federal Reserve will provide more stimulus via bond buying this year, even as improving economic data have led many in the market to think the sun may be setting on that particular strategy.
"For some time, our call has been that the Federal Reserve will undertake additional balance-sheet action in the first half of 2012," writes Vincent Reinhart, an economist with the bank and a former top-level Federal Reserve staffer.
He argues it's most likely the Fed will act to expand its balance sheet via Treasury and mortgage bond buying--in market parlance, QE3--at either the April or June Federal Open Market Committee, and that the ultimate size of the program could tack on $500 billion to $700 billion onto what is currently a $2.9 trillion balance sheet.
There's also a chance they will put in place a modified version of the current effort to sell short-dated bonds to buy longer-dated securities.
Why act? Reinhart says the second half of the year will box the Fed in politically. Officials will not wish to be seen starting a high-profile action in the thick of the presidential campaign. Also, he reckons growth will still be too weak, and inflation will be falling short of the Fed's 2% target.
The recent improvement in economic news, especially on the jobs front, will increasingly be seen as a head fake, the Morgan Stanley economist said. "We share the view that the fillip to economic growth associated with a restocking of inventories is fading and that real GDP growth will slow notably in the current quarter," Reinhart said. "Anxiety-inducing headlines that the economy is losing steam will be conducive to Fed action."
The forecaster noted that he understands how market participants may be marking down the chances of action, but he said part of that may be attributable to a misreading of some of the recent Fed rhetoric. Reinhart acknowledged the surge in oil prices creates a decent chance that inflation data may look less benign.
That said, he believes Fed Chairman Ben Bernanke will view those increases as something that lowers consumer spending power. Put another way, oil prices are a greater negative for economic growth, in the Fed leader's way of thinking.
For many in markets, the case for the sort of stimulus Reinhart describes will face a major test Friday with the release of the February jobs report. It's expected to come in pretty strong and continue the trend of falling unemployment rates. But as fast as the jobless rate may be improving, it remains historically high. It's easy to see why central bankers might want to act.
Late last week, San Francisco Fed President John Williams noted that if the recovery suddenly got weaker, or inflation stayed well below the Fed's 2% target, he could see the Fed buying mortgage bonds, in a bid to stimulate growth. In testimony before Congress last week, Bernanke kept his options open and didn't commit to any particular policy outlook.
On Monday, however, Dallas Fed President Richard Fisher made the case for those who see little value in more stimulus. "I am personally perplexed by the continued preoccupation, bordering upon fetish, that Wall Street exhibits regarding the potential for further monetary accommodation," he said.
He went on to say a huge amount of the stimulus the Fed has already delivered is "lying fallow, not being employed in the real economy." Furrowing his brow, he observed, "Financial market operators keep looking and hoping for more. Why? I think it may be because they have become hooked on the monetary morphine we provided when we performed massive reconstructive surgery."
eFXnews : [AUTOLINK]FED[/AUTOLINK] WATCH: Morgan Stanley Still Sees Strong Chances For QE3
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