Expect QE3 by year-end, if job market doesn't improve: HSBC

The US Federal Reserve kept rates unchanged, extended Operation Twist and hinted that it is prepared to launch a third round of quantitative easing if required.

In an interview to CNBC-TV18, Kevin Logan, chief US economist at HSBC says, the FOMC is quite concerned about the state of the labour market. “Job growth has slowed down quite rapidly in last four months. If we don’t see drop in unemployment rate in next few months, we may get a QE programme later this year,” he adds.

Below is the edited transcript of his interview with CNBC-TV18's Udayan Mukherjee and Mitali Mukherjee. Also watch the accompanying video.

Q: Would the markets be okay with extension of Operation Twist or is there lingering sense of disappointment that the Fed did not do more as we are seeing in many markets today?

A: The FOMC is quite concerned about the state of the labour market. Job growth has slowed down quite rapidly in last four months. There are number of things holding back the economy's growth. There is the fiscal contraction taking place. There is the spillover from the developing Europe recession. There are concerns about where the economy will be at end of the year, when we approach the sudden rise in tax rates and spending cuts from the Federal government.

The officials at the Fed have lowered their forecast for GDP growth. They have raised their forecast for unemployment. That has led them to decide they should really ease monetary policy further. They have taken a small step in that direction. They are extending the Operation Twist through the end of the year. So, they will buy more long-term securities and sell their short-term securities. That should put some pressure on long-term interest rates.

But having done this, it does not preclude further action. They could later in the year initiate further quantitative easing (QE), if things don’t get better. They suggested that in their statement, when they said they are prepared to take further action to promote a sustained improvement in the labour market. So, if we don’t see drop in unemployment rate in next few months, we may get a QE programme later this year.

Q: They did hold out the promise of doing more or stepping in with the QE3, if indeed the situation warranted it. How likely is it you think that that kind of announcement may come by the next policy?

A: I don’t think they will act at the next meet. Having just initiated a new programme of easing policy, they will probably just wait to see what the effects might be. They will wait a few months. So, I wouldn’t expect another easing before September or October- November.

Bernanke had a press conference, he was asked several times about the situation in Europe, he generally said they were consulting and co-operating with European leaders. But he gave no hint at all that there was any coordinated programme underway or being considered right now between Fed and other central banks. He was asked several times and he might have revealed something, but he continued to insist that European leaders will take care of European problems. He gave no hint, no suggestion that there might be coordinated efforts anytime soon.

Q: What about the outlook for risk assets over the next few weeks? Given what the Fed said last night and as you pointed out it stopped short of talking about coordinated policy action and what is likely and what you expect from European authorities over the next few weeks, where does it leave risk assets in the near-term?

A: I think that in the foreign exchange market what we will see is that some of these so-called risks on currencies will benefit from the Fed action. By easing monetary policy they may promote a faster rate of growth. For some investors, there are expectations that inflation might be a bit higher. That ofcourse would spur more interest in commodity investments.

But the initial reaction today was rather mixed, there was a lot of volatility in gold markets, a lot of trading in a wide range, but not much changed over the day. The risk on currencies that is the Australian dollar and the Canadian dollar and so on did appreciate on the day. So, there is some interest there that monetary easing in the US will benefit these currencies. But the Fed's action was rather modest. It was well expected and anticipated that they will do something similar to what they did, an extension of Operation Twist. So, the market was prepared and we didn’t see a big reaction on the day.