Should be interesting to see what the language is coming out of the Federal Open Market Committee tomorrow. I expect essentially no change in the Fed balance sheet or language about the target rate. The Fed will continue to re-invest principal payments on agency debt and mortgage-backed securities (as they started to do last month) and they’ll retain the language about keeping the target range of the federal funds rate at “exceptionally low levels…for an extended period.” There’s not been much material deterioration in the outlook over the past month other than weak (but expected) existing home sale numbers post-tax cut and a glum Census report on the increasing poverty rate. There’s a bit less discussion of deflation now given August data showing a flat core consumer price index and, in fact, perhaps more concern afoot now that further quantitative easing by the Fed could ignite inflation fears. Likely, this will mean little upward pressure on mortgage rates near-term except to the extent that more inflation fears creep in. The average national mortgage rate for a 30-year fixed loan in the Zillow Mortgage Marketplace today was 4.34%.

Other options would be for them to: 1) stop re-investing in MBS (i.e., draw down their balance sheet); 2) introduce modest additional stimulus; or 3) include language that they may add a stimulus soon if conditions warrant (but not do so now). My sense is they are concerned enough about a double-dip that they won’t do #1. A double-dip doesn’t seem very likely but its probability is non-trivial (and you’d like it to be trivial given the attractiveness of policy options if we do encounter it). I think #2 seems premature given no material degradation since the FOMC last met, the fact other central banks are now in tightening mode, and some emerging fears about inflation (have you seen gold prices lately?). Option #3 is safer than #2 but it still sends a chilling message to the markets about the Fed’s worries, again something I don’t sense the FOMC is going to want to do tomorrow given their current outlook.