U.S. Federal Reserve officials are growing more confident in the U.S. economic recovery, stoking speculation on Wall Street that the central bank is preparing to wean financial markets off a steady diet of Fed cash.
Since September, the central bank has been creating $85-billion (U.S.) a month to purchase Treasuries and mortgage-backed securities, a policy known as quantitative easing. The program's life is contingent on the strength of the economy – the Fed is committed to ending it as soon as it detects substantial improvement in the outlook for employment.
"The U.S. economy seems to be preforming pretty well right now," Charles Evans, head of the Federal Reserve Bank of Chicago, and a voting member of the Fed's policy committee, said in a speech Monday. "I'm optimistic that the labour market has been doing much, much better and that unemployment is going to continue to go down."
Economic indicators have been mixed of late, creating uncertainty about the Fed's course over the months ahead. Federal Reserve chairman Ben Bernanke could settle doubts when he testifies before the Joint Economic Committee of Congress on Wednesday.
His testimony could have a significant impact on financial markets. The Fed has been keeping interest rates at historically low levels by bidding up the cost of bonds, taking advantage of the inverse relationship between price and yield. The bank also is boosting the stock market by forcing private investors to seek better returns than can be found in fixed income. The Standard & Poor's 500 index hit a new intra-day record on Monday at 1,673 before retreating and closing down 0.1 per cent.
When the Fed's 19-member policy committee last met three weeks ago, officials emphasized they could either increase or decrease the scale of their monthly bond purchases, depending on the outlook for hiring and inflation.
In the weeks since, positive news on the economy has outweighed the negative, if only slightly. The jobs market continues to strengthen, and the housing rebound remains a force. Retail sales and consumer confidence both posted significant gains April, according to data released last week.
"It's clear that the labour market has improved since September," John Williams, the head of the San Francisco Fed, said last week. "If all goes as hoped, we could end the purchase program some time late this year."
U.S. non-farm payrolls grew an average 208,000 over the six months to April – when the Fed expanded its quantitative-easing program in September, payrolls were growing at a monthly average of 97,000, although revisions have since boosted that number.
"The glass is half-full and filling, not half-empty and emptying," Jim O'Sullivan, chief U.S. economist at High Frequency Economics in Valhalla, New York, said Monday in a report on Fed policy. "We expect tapering [of the bond-buying program] to begin later this year and QE to end by early 2014."
Some members of the Fed's policy committee want to begin unwinding their stimulus efforts immediately. A vocal minority of policy setters worries that the hundreds of billions of dollars that the Fed has created could cause runaway inflation once economic growth improves. This group also frets that by taking an outsized role in financial markets, the Fed has skewed normal market behaviour, which could result in asset-price bubbles.
"I believe that labour-market conditions warrant scaling back the pace of purchases as soon as our next meeting," in June, Charles Plosser, president of the Philadelphia Fed, said last week.
For his part, Mr. Evans, the only one of the recent Fed speakers who actually has a vote on policy decisions this year, indicated he is in favour of leaving the bond-buying policy alone for now. "Currently we have the appropriate monetary policy in place," he said.