Fed to Boost Operation Twist With QE3 Jolt, Bank of America Says

Federal Reserve policy makers will probably announce in September a third round of bond purchases under quantitative easing to spur U.S. economic growth, according to Bank of America Corp.

The firm estimates the Fed will buy $500 billion in securities, primarily in mortgages, Priya Misra, head of U.S. rates strategy at Bank of America Merrill Lynch in New York, said yesterday at a company press conference. Policy makers last week expanded their Operation Twist effort to cap borrowing costs. The new move will come as indicators, including the so- called break-even rate between Treasury Inflation Protected Securities and nominal U.S. notes, signal lower consumer prices, she said.

“The Fed will most likely do QE, but not yet,” Misra said in New York. “When TIPS break-evens decline and sentiment falls, the Fed will move to put a floor on risky assets and confidence.”

The central bank on June 20 expanded Operation Twist, its program to replace $400 billion of short-term Treasuries in its portfolio with longer-term debt to lengthen the average maturity of its holdings, by $267 billion and extended it until year-end.

Bank of America Merrill Lynch, one of the 21 primary dealers that trade Treasuries with the Fed, also expects the Fed at its August meeting to say it plans to hold its target funds rate at virtually zero until mid-2015. The rate has been at zero to 0.25 percent since December 2008, and policy makers have said they intend to keep it there until late 2014.

The central bank has kept the economy growing for 11 straight quarters by buying $2.3 trillion of assets and pursuing its maturity-extension effort. It announced its first asset- purchase program in November 2008.

‘Politically Easier’

“As the Fed sees worse data, it will need to react with another policy,” Misra said after the conference in an e-mail. “Buying mortgage-backed securities will help keep mortgage rates low, so that might be politically easier for the Fed to buy.”

Falling mortgage-bond yields mean home-loan rates are at record lows, with 30-year borrowing costs on June 21 at 3.66 percent, down from last year’s high of 5.05 percent, according to weekly surveys by the finance company Freddie Mac.

“We expect QE3 to be concentrated in MBS, but to have a Treasury portion as well,” Misra said. “We expect a Treasury portion because the MBS market will not be able to handle a big purchase program.”

The Fed said last week it’s “prepared to take further action as appropriate to promote a stronger economic recovery and sustain improvement in labor market conditions in a context of price stability.”

Break-Even Rate

The difference in yields between 10-year notes and TIPS, which represents traders’ expectations for the rate of inflation over the life of the securities and is known as the break-even rate, was 2.08 percentage points yesterday, down from the 2012 high of 2.45 percentage points on March 20. It touched a 2012 low of 1.9 percentage points on Jan. 3.

Bank of America forecast a 1.4 percent growth rate in gross domestic product in the third quarter, compared with a 2.3 percent median forecast of 68 economists surveyed by Bloomberg.

The firm forecast the yield on the 10-year note will climb to 1.9 percent by year end. A Bloomberg survey of 66 economists forecast the median yield on the benchmark note will rise to 2.1 percent by then.

The yield on the 10-year note touched a record low 1.4387 percent on June 1 after reaching a 2012 high of 2.40 percent on March 20.

To contact the reporter on this story: Susanne Walker in New York at swalker33@bloomberg.net

To contact the editor responsible for this story: Dave Liedtka at dliedtka@bloomberg.net

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