FOMC, ECB, RBA Meetings: What is Priced in?

The Federal Reserve, European Central Bank and the Reserve Bank of Australia have monetary policy meetings scheduled this week and some investors expect these central banks to change monetary policy. Here’s what the market is pricing in according to interest rate futures. You can compare them with the Central Bank expectations back in September. What is interesting is that the market does not expect the ECB to cut interest rates this year even though many economists predict a 50bp cut in December.

FED – Nada for 2011 and 2012

ECB – 25bp rate cut by July (sharp upgrade from Sept when rate cut expected in Dec)

BOE – Nada for 2011 and 2012 but slight shift to dovish bias

BOC – Rate Cuts now expected in 2012, down from rate hike by April

RBA – 25bp Rate cut by Dec – upgrade from 100bp by year end

RBNZ – No Major Changes, Rate Hike Expected July 2012

And here are the details:

What Investors Expect Central Banks to Do in 2011 and 2012

Central Bank Interest Rate Expectations can and do change based upon economic and market developments. The last time I provided updated CB expectations was in July (yes, I apologize for being tardy) but since then we have seen major changes in investors expect central banks to do this year and next.

Here are the cliff notes

FED – Nada for 2011 and 2012

ECB – 25bp rate cut by Dec?! (In July no rate hike or cut was expected for 2011 and 1H2012)

BOE – Nada for 2011 and 2012 but slight shift to dovish bias

BOC – Rate Cuts now expected in 2012, down from rate hike by April

RBA – Major Rate Cuts Expected – 100bp by year end?!

RBNZ – No Major Changes, Rate Hike Expected March 2012

And here are the details:

BNN Video – Fed’s Options

I was on BNN last night talking about the Fed’s options at Jackson. Click on the link to watch the video:

From the most flimsy to the most aggressive, here are 5 of the Fed’s options:

1. “We are also worried” – If the Fed opts to do nothing more than express their concern about the economy and give an ambiguous pledge to do all that is necessary, investors will be sorely disappointed.

2. Extends 2013 pledge to Securities Portfolio – When the Fed met earlier this month, they tweaked the extended language sentence of their FOMC statement to say that the Fed Funds rate would remain at exceptionally low levels at least through mid 2013. They can opt to extend this pledge to their securities portfolio which leaves open the door to QE3 without explicitly initiating it.

3. Operation Twist – The Fed could also bring back a tool used in the 1960s that twisted the yield curve by selling short term bonds and buying longer term bonds. This would drive short term yields up and long term yield down which effectively extends the maturity of their securities portfolio without increasing the balance sheet. This would be a more aggressive action than another language tweak (see #2).

4. Reduce Interest on Reserves to ZIRP – The central bank could also cut the interest paid on reserves from 0.25 percent to 0 percent or cut swap line rates in order to bring down the tremendous amount of liquidity.

5. Another Round of QE – The most aggressive options would be for the Fed to introduce another round of stimulus but given the level of inflation and the criticism of QE2, this option may be the least likely. One other possibility is inflation targeting but this “nuclear option” is so unlikely that it is not allocated its own category.

Comparing the March and Jan FOMC Statements

Compare the changes made to March FOMC statement with the Jan one.

FOMC Statement January 26, 2011

Information received since the Federal Open Market Committee met in December confirms that the economic recovery is continuing, though at a rate that has been insufficient to bring about a significant improvement in labor market conditions. Growth in household spending picked up late last year, but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit. Business spending on equipment and software is rising, while investment in nonresidential structures is still weak. Employers remain reluctant to add to payrolls. The housing sector continues to be depressed. Although commodity prices have risen, longer-term inflation expectations have remained stable, and measures of underlying inflation have been trending downward.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. Currently, the unemployment rate is elevated, and measures of underlying inflation are somewhat low, relative to levels that the Committee judges to be consistent, over the longer run, with its dual mandate. Although the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability, progress toward its objectives has been disappointingly slow.

To promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to continue expanding its holdings of securities as announced in November. In particular, the Committee is maintaining its existing policy of reinvesting principal payments from its securities holdings and intends to purchase $600 billion of longer-term Treasury securities by the end of the second quarter of 2011. The Committee will regularly review the pace of its securities purchases and the overall size of the asset-purchase program in light of incoming information and will adjust the program as needed to best foster maximum employment and price stability.

The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels for the federal funds rate for an extended period.

The Committee will continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to support the economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Richard W. Fisher; Narayana Kocherlakota; Charles I. Plosser; Sarah Bloom Raskin; Daniel K. Tarullo; Kevin M. Warsh; and Janet L. Yellen.