QE unlimited?

Some brief thoughts on the most hyped up event since the premier of the movie Independence Day. I think a likely outcome of the meeting is that the FED continues to add flexibility in order to disappoint no one. In line with the current program of keeping the FED balance sheet intact, a “smart” way of making sure that nobody is disappointed without coming across as being in panic mode is to set a flexible target. For example to reserve the themselves the right to expand the balance sheet up to 800 billion USD, if needed.

This can also be motivated by the fact that the feedback effects of them buying the long-bond and increase in pre-payments in the existing portfolio is hard to predict. This would also give them flexibility in managing the problem of supply of treasuries, as the FED can only hold 35% of a single CUSIP.

Maybe this sounds like a too dovish outcome. But it is important to remember the dual mandate of the FED, price stability and full employment. In the view of the FED, as long as there is unemployment, there is a slack in the economy and inflation will not be a problem. In the current situation this means that they can pretty much go all in with the few weapons they have at their disposal, QE, in order to bring down unemployment.

Moreover, in the choice between weaker dollar and weaker stocks, it is pretty clear that weaker dollar is the preferred choice. And above all, they want to avoid disruptive market volatility, which will surely come if the surprise to the downside.

So with one week EURUSD volatility trading about 7 vols above realized volatility EURUSD needs to end up above 1.4170 or below 1.3630 next week if the market is right about this one (spot ref 1.39). I think, similar to Independence Day, this might be a huge hype the rumor, sell the fact event.