The Fed faces a challenge at its upcoming FOMC meeting: how to suggest it is still actively pursuing new policies without making any specific new commitments.

On the one hand, the economy and capital markets clearly remain very fragile and policy is focused on preventing an even deeper downturn. The markets are hoping for two announcements: an expanded MBS buying program and a new longer-term Treasury buying program. Some traders argue that bond yields will bounce higher if the Fed fails to take another step toward a buying program.

On the other hand, it seems too early to move ahead with these changes. The Fed has spent only $262bn of its allocated $600bn in MBS and agency debt buying and could easily wait until its April 28-29 meeting to announce an extension of this program. Similarly, it does not seem ready to move ahead with Treasury buying. In its January directive, the FOMC said it “is prepared to purchase longer-term Treasury securities if evolving circumstances indicate that such transactions would be particularly effective in improving conditions in private credit markets [emphasis added].” What it seems to be saying is that direct intervention in credit markets is a more effective way to improve credit conditions than buying public credit. Indeed, this was the conclusion of a speech by New York Fed President Dudley on March 6. The TALF program is designed to enhance private credit flows directly, and it is much too early to judge whether it will be a success.

The solution is for the Fed to do an incremental change in language that falls short of a true commitment. In other words, offer an engagement ring, but without a marriage date. It is very hard to predict exact language, but two changes might make sense. First, it could underscore that it plans to expand its balance sheet significantly:

Old statement: policy is “likely to keep the size of the Federal Reserve’s balance sheet at a high level.”

New statement: policy is “likely to continue to boost the size of the Federal Reserve’s balance sheet.”

Second, it could suggest a baby step toward a Treasury buying program:

Old statement: “The Committee also is prepared to purchase longer-term Treasury securities if evolving circumstances indicate that such transactions would be particularly effective in improving conditions in private credit markets.”

New statement: “The Committee is closely monitoring market conditions and is prepared to purchase longer-term securities if….”

There is some chance the Fed will move ahead aggressively at this meeting, and ultimately we do expect more action from it. We expect it to expand its mortgage buying program once the funds get low. And we think it will end up buying long-dated Treasuries under two circumstances:

1) if the TALF program proves ineffective in reviving credit markets and

2) if the Treasury market starts to sell off in a disorderly manner before real signs of economic recovery.