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Bernanke should lay groundwork for QE pullback

Tuesday, 17 Dec 2013 | 6:35 PM ET
Andrew Harrer | Bloomberg | Getty Images

It should be a slightly more hawkish Ben Bernanke presiding over his final press briefing Wednesday, even though many Federal Reserve watchers say odds are against a move to taper back on stimulus just now.

Certainly Wall Street is prepared to hear the Fed chairman portray it as being closer to paring back its quantitative easing program, which has helped balloon the Fed's balance sheet to $4 trillion. But he is also likely to discuss the need for more sustainable gains in the job market and about the lack of inflation. The Fed releases its statement and latest economic projections at 2 p.m., ahead of Bernanke's 2:30 p.m. briefing.

"We still think they're not going to do anything tomorrow in terms of actual action," said Bill Stone, chief investment strategist at PNC Wealth Management. "We think they're going to punt until January. Obviously it depends whose survey you look at, but there are a significant number of managers that believe—and it wouldn't blow me out of the water—if they did do something tomorrow. The odds, I think, are greater than 50 percent that they wait until January."

CNBC's Fed Survey this week showed that expectations are now that the Fed will begin to move away from its $85 billion in monthly bond and mortgage purchases in February—two months earlier than expected in an October survey of fund managers and others. Fifty-five percent see the Fed tapering in January or December, while more than 40 percent expect it in March or later.

(Read more: The Fed will never end QE: Marc 'Dr. Doom' Faber)

Bernanke's successor, Fed Vice Chair Janet Yellen, is expected to be approved shortly, and this could be the final meeting presided over by Bernanke, who guided the Fed through the financial crisis and headed the implementation of its extraordinary policies. His term officially ends after the January meeting.

Stone said that if there is a move to taper its bond-buying Wednesday afternoon, the stock market would sell off, but less than 1 percent. If the Fed does nothing, stocks could rally about the same percentage. Treasurys were higher Tuesday, helped by a strong 2-year auction. The yield on the 10-year slipped to 2.839 percent, and bond strategists say it would head toward 3 percent if tapering were announced.

"It may give us greater odds for a Santa rally if they don't taper," Stone said. The rally is named for the trading days right after Christmas and the first few days in January, when market bias is often higher.

But the markets are not primed for tapering just yet, according to Pimco portfolio manager Tony Crescenzi.

"Tomorrow wouldn't be the best timing for taper because the market isn't expecting it," he said. "It was OK to surprise the markets with a positive one in September, but it's not as OK to surprise the market with one that is somewhat more negative, unless the Fed finds a potent mix of goodies to help soften the blow."

Crescenzi said that the Fed could reduce the interest paid on excess reserves but that it is not likely. It may also attempt to guide markets to expect low short-term rates for longer by cutting the 6.5 percent unemployment it set as the level at which it would begin to raise short-term rates.

The unemployment rate is 7 percent.

"The Fed is trying to pivot from a bond buying to a communications strategy," he said.

(Read more: Fed-inflated stocks a 'hall of mirrors': Jim Grant)

"The reason tomorrow feels somewhat ill-timed is because the Fed already had one communications mishap this year," Crescenzi said. Markets were surprised when it held back from tapering in September because of concerns that fiscal restraints were hurting the economy.

But Ward McCarthy, chief financial economist at Jefferies, said the Fed has already readied the runway and needs to act to pare back bond-buying.

"I think the statement language will indicate they are reducing the purchases by $5 billion but would implement the reduction in Treasurys," he said. The Fed is currently purchasing $45 billion in Treasurys and $40 billion in mortgage securities each month.

The initial slowing of bond-buying is actually still a long ways from removing stimulus. Besides its QE purchases, the Fed actively replaces securities on its balance sheet as they mature, and it has no plans to unwind the giant holdings on its balance sheet.

Time to taper: Former Minneapolis Fed president
Former Minneapolis Fed President Gary Stern explains that most conditions are right for the Fed to start paring back.

The Fed is likely to provide new forecasts Wednesday that show officials see lower short-term rates for a longer period," McCarthy said. For instance, several members see the fed funds target rate above 3 percent in 2015.

"I think in 2015, the central tendancy is lowered by 150 to 100 basis points," he added.

The Fed could also dissuade markets that normalized levels for interest rates need to be the traditional 4 percent, in an effort to keep rates lower for a longer period.

"The most important message the Fed can send is that it will be patient with regards to the timing and magnitude of any reversal or tightening of policy," Crescenzi said.

In addition to the Fed meeting, housing starts and building permits are released at 8:30 a.m. There are also earnings from FedEx, General Mills and Lennar before the opening bell. Paychex, Herman Miller, Oracle and Steelcase report after the close.

—By CNBC's Patti Domm. Follow here on Twitter @pattidomm.

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  • Patti Domm

    Patti Domm is CNBC Executive Editor, News, responsible for news coverage of the markets and economy.

  • A CNBC reporter since 1990, Bob Pisani covers Wall Street from the floor of the New York Stock Exchange.

  • Sharon Epperson is CNBC's senior commodities and personal finance correspondent.

  • JeeYeon Park is a writer for CNBC.com. Follow her on Twitter: @JeeYeonParkCNBC

  • Rick Santelli joined CNBC Business News as an on-air editor in 1999, reporting live from the floor of the Chicago Board of Trade.

  • Senior Producer at CNBC's Breaking News Desk.

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