End of Stimulus? Why It Isn't All Bad News
The Federal Reserve's minutes on Thursday hinted at an earlier-than-expected end to its unprecedented bond buying program, triggering a sell-off in equities as investors worried about an end to historically low interest rates. The upside? Analysts say this is the Fed's way of weaning markets off the drug of quantitative easing and reflects the central bank's confidence in the U.S. economy.
Minutes of the Fed's December policy meeting showed that officials were split on when to halt the bond buying programs that have been adding $85 billion a month to the central bank's assets. A few wanted the programs to continue until the end of 2013, several others called for them to end well before then and some want them halted right away.
The minutes also left no clear sign of the future course the central bank would take, leaving the date of the potential winding down uncertain and unnerving markets. In September, in an unprecedented move, the Fed linked its bond buying program to unemployment, pledging to continue the scheme until the U.S. jobless rate falls to 6.5 percent, from the current 7.7 percent.
According to Sam Chandan, president and chief economist with Chandan Economics, the Fed is trying to signal two things. The first is that the Fed believes that the U.S. economy is developing "its own momentum" and a continuation of the easy monetary policy is not warranted. The second is that financial markets need to get used to the idea that this is the beginning of the end of easing.
"They are signaling to the market that extraordinarily accommodative monetary policy is not something that will last forever," Chandan told CNBC Asia's "Squawk Box" on Friday. "They have done this in several ways – putting time frames around it, and with discussions around where rates might begin to rise. But the market hasn't internalized a lot of that.
"Unlimited addition of Treasurys to the Fed's balance sheet, which stood at $2.9 trillion on January 2, may create a huge problem down the road for the Fed when it wants to sell those bonds, analysts say. Already, bond yields are beginning to rise, with the 10-year yield hitting a near eight-month high of 1.904 percent on Thursday, up from Wednesday's 1.84 percent, which is also a spike.
(Read More: This Could Be the Year Bonds Start to Deflate)
"If the market believes that this (easing) is going to go on forever, that's a pretty dangerous thing," Chandan said.
The Fed needs to balance the risks and benefits of easing and it was a matter of time before the Fed pulls back on the program, he added.
"At some point, they are going to reach this juncture," Chandan said. "They're going to have to evaluate the situation and go, wait, there are risks we may be introducing and the benefits are not as great once the economy begins to develop its own momentum."
Brighter Economic Prospects
Indeed, more signs have emerged that the U.S. economic recovery is on firmer ground, adding support to the view that the easing program should wind up sooner than expected.
The ADP National Employment Report on Thursday showed the private sector added 215,000 jobs in December, more than November's gain of 148,000. The data comes ahead of the all-important non-farm payrolls on Friday, which could show payrolls rising as much as 200,000 last month, the rosiest forecasts show, giving the Fed more reason to pull back on easing.
(Read More: GDP Growth Pushed Up to 2.7%; Jobless Claims Slip)
Still, according to Michael John Materasso, executive vice president and portfolio manager at Franklin Templeton Institutional, weaning the economy off the stimulus drip feed will likely be a gradual process that will not rock markets too much.
"The Fed will stop purchasing Treasurys when the economy is doing better," he said. "But keep in mind that it's a process that goes along. They will probably have a period of time when they do nothing. Then from there, they assess the situation. There are lots of possibilities out there."
A potential increase of interest rates may also spur people to consider buying homes, economists tell CNBC. This will in turn drive the housing sector, which makes up about 17 percent of gross domestic product, according to the National Association of Home Builders.
"If the Fed is going to take some QE (quantitative easing) off the table by the end of year, this might cause a sense of urgency in the public to actually borrow and take advantage of those rates," said Michael Gayed, chief Investment strategist with fund manager Pension Partners. "That could accelerate the economy."
"I know it (end of easing) is seen as a negative but we live in a world of over-reaction to perceived negatives and under-reactions to real positives," he added.