Today, financial markets wait with bated breath to see if the Federal Reserve will finally ease off of its latest round of economic stimulus, an open-ended asset purchase program known as QE3. The announcement will come at the conclusion of the latest two-day meeting of the bank's Federal Open Market Committee, and is widely expected to signal the beginning of the end of the bank's third round of quantitative easing.
Currently, the Fed is keeping interest rates low by purchasing $85 billion in treasury bonds and mortgage-backed securities each month, a tactic it first announced in September 2012. The central bank put no end date on the program, but Fed Chairman Ben Bernanke signaled in June that dialing back those purchases would depend upon improvements in economic data.
If inflation and the job market picked up enough, Bernanke said then, the FOMC anticipated that "it would be appropriate to moderate the monthly pace of purchases later this year; and if the subsequent data remain broadly aligned with our current expectations for the economy, we would continue to reduce the pace of purchases in measured steps through the first half of next year, ending purchases around midyear."
Bernanke's approximate roadmap for tapering, combined with a slowly declining unemployment rate, have led many economists to believe the committee will finally decide to taper this month. However, they believe that the taper will be small, in line with modest labor market improvements. Many experts have predicted a $5 billion to $15 billion reduction in monthly purchases.
In a commentary on the upcoming meeting, Wells Fargo Advisors on Tuesday said that while it is possible that the Fed would stay the course, a taper of $10 billion to $15 billion would be more likely.
"Anything above that modest amount and stock investors will not be happy. They will think the Fed would be tapering too quickly, and we would expect a negative reaction in the marketplace," wrote Scott Wren, senior equity strategist at Wells Fargo.
Likewise, investment firm Keefe, Bruyette & Woods this week pointed to the weak labor market and concluded that the fed will either decide on "very modest tapering" or hold off altogether until a later meeting.
Still, the Fed may decide to ease off of the stimulus gas pedal for reasons that have nothing to do with the job market or inflation. If the Fed does not decide to pull back on bond purchases this month, its next scheduled opportunity to taper would come with the FOMC's next regular meeting, in late October. The particulars of that timing could make an earlier taper more likely, as Credit Suisse noted this week, according to Business Insider. Central bankers may not want to wait until then, as Washington may at that time also be embroiled in yet another market-rattling fight over the debt ceiling.
Easing off of stimulus may signal a healing economy, but it could also make for some wobbles in the weeks and months ahead. Quantitative easing has worked by artificially boosting stocks and the housing market, says one analyst, essentially helping the U.S. economy imitate strength until the recovery is more firmly in place.
"They've been faking prosperity, hoping that we'll make it. And all the QE3 and QE2 and all this kind of stuff has all been around faking prosperity," says Martin Leclerc, chief investment officer and portfolio manager of Barrack Yard Advisors.
Stock markets could therefore react poorly to a taper announcement on Wednesday. But then again, Leclerc notes that the taper may already be priced into the stock market – thanks to the Fed's forewarnings, markets have anticipated a taper for several months now. Even Bernanke's mere mention of a taper in June caused the S&P 500 and Dow Jones Industrial Average to plummet.
Just as the end of QE may not cause a massive stock market correction, a hike in mortgage rates may not put the brakes on a strong housing recovery. Mortgage rates have risen considerably this year, and Americans have continued to buy homes.
"The increase in rates since May has put a crimp in housing but has not stopped the recovery," says John Canally, investment strategist at LPL Financial. "Around 50 percent of sales this year and last have been for cash, so half the market [is] totally unaffected by [the] rate rise."