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Fed expected to twist again

WASHINGTON (MarketWatch) -- The Federal Reserve is likely to extend its Operation Twist program at the end of its two-day meeting on Wednesday, a growing number of Fed watchers said over the weekend.

"We now expect the Fed to ease policy further at next week's meeting," Barclays Capital economist Dean Maki said in a note to clients. "We see a short-term extension of Operation Twist as the most likely outcome."

Michael Gregory, senior economist at BMO Capital Markets, said more and more economists were jumping on the "bandwagon" of an extended Twist.

The move would serve several purposes, but would mainly show the Fed's resolve to act and help shore up confidence, said Millan Mulraine, economist at TD Securities.

The current $400 billion Twist program is set to expire at the end of June. It gets its name from the Fed trying to twist the yield curve by selling short-term securities that it holds while buying longer-term securities.

Analysts said the Fed has about $180 billion of short-term Treasurys left to sell. There was some speculation that the Fed might buy mortgage-backed securities in the new round.

The risks of extreme financial contagion subsided Sunday night in the wake of the Greek election. Economists said this would lower the odds for a massive new bond-buying program, known as the third quantitative easing or QE3. See report on Greek election results.

Former Fed governor Donald Kohn said there was not much relief for the Fed in the wake of the Greek elections. He noted that tensions in the euro area remain pretty intense and there was not a big relief rally that would have eased financial conditions in the U.S.

The people on the Fed who are arguing in favor "of doing a little something." will feel that their arguments have been strengthened over the past few weeks, Kohn said.

The Fed has bought over $2.3 trillion of Treasurys and housing-related assets to bring down interest rates. The Fed's traditional short-term interest-rate policy tool -- the fed funds target -- has been close to zero since December 2008.

Fed Chairman Ben Bernanke certainly didn't endorse more easing in his testimony to Congress last week, and as a result, some analysts think the U.S. central bank will stay on hold to see how things pan out over the next few months. But they admit it is a close call.

One factor that still isn't clear is how much of the current economic slowdown is due to weather.

Analysts think that the warm winter may have brought forward some economic activity, leading to slower growth over the past few months.

"It behooves the Fed to wait until the true economic trend is discernible," Gregory said.

But the economists who predict more Twist say it was May's weak retail sales data that will convince the Fed to jump back in and ease. See charts of recently published economic data.

After the weak consumer spending data, second-quarter gross domestic product is forecast to come in below 2%, the fourth period out of the past five with such sluggish growth.

Another way to bring down rates would be to push out the Fed's guidance that they are likely to keep rates steady beyond late 2014. But most analysts are doubtful that Fed officials will take this step.

John Stoltzfus, chief investment strategist at Oppenheimer Asset Management, said in a note to clients that disappointed speculators "could throw a tantrum" and push markets lower if the Fed decides to stay on hold on Wednesday.