The recent stretch of disappointing U.S. economic data and financial market turmoil has increased the odds that the Federal Reserve will launch a third round of quantitative easing (QE3) later this month, according to Goldman Sachs.
In a recent report, Jan Hatzius ' the firm's chief U.S. economist ' wrote that 'Our confidence that the FOMC will ease policy once more at the June 19-20 meeting has also grown. At a time when Fed officials are far short of their dual mandate of maximum employment and 2% inflation, financial conditions should be accommodative and GDP growth should be well above trend in order to re-employ displaced workers and avoid a gradual transformation of cyclical into structural unemployment'Moreover, both financial conditions and growth have been moving in the wrong direction, to a degree that we think warrants action.'
As for the composition of QE3, the Goldman Sachs economist's 'baseline' case is that the Fed 'will purchase a mixture of mortgages and long-term Treasuries, financed via balance sheet expansion and possibly coupled with an extension of the forward guidance into 2015.'
'This would be considerably more powerful than an extension of Operation Twist or other ways of changing the composition of the balance sheet, which are possible alternatives but are limited by the relatively modest amount ($200bn) of short-term paper that is still available for sale on the Fed's balance sheet,' Hatzius added.  'We still think that Fed officials might decide to 'sterilize' balance sheet expansion via reverse repurchases or term deposits.'
Although Hatzius did not specify the size which he expects QE3 to be, he went on to say that 'We may get a better sense on all of these issues from Chairman Bernanke's testimony to the Joint Economic Committee of Congress on Thursday or other Fed speeches this week.'