End of Stimulus? What's Behind Fed's Surprise Statement

Federal Reserve Building, Washington, D.C.
Mark Chivers | Getty Images
Federal Reserve Building, Washington, D.C.

In a surprise move, several Federal Reserve members said they want to end quantitative easing this year, but analysts said that doesn't mean the central bank will make a major policy shift anytime soon.

The Fed sent ripples through financial markets Thursday when minutes of its Dec. 12 policy meeting showed that "several" members would like to stop the bond-buying program before the end of this year. (Read More: Some Members See QE Ending This Year)

That prompted traders to speculate about an early end to the Fed's four-year stimulus program—and the threat of higher interest rates ahead.

"It's not a sea change," Bill Gross, Co-chief investment officer of PIMCO, told CNBC. "But it's a little bit of a surprise. The minutes basically say a few wanted QE to end about the end of 2013 and several wanted it well before. That means four or five members are in the opposing camp."

Treasury yields rose, the dollar gained, and stocks fell slightly after the 2 p.m. Fed release. The 10-year yield rose to 1.91 percent, its highest level since May 10. (Read More: Stocks End Lower on Fed Minutes)

Despite the market reaction, Gross told "Street Signs" that Fed Chairman Ben Bernanke—along with Vice Chairman Janet Yellen and New York Fed President William Dudley—aren't likely to switch gears right away.

"The three musketeers — Bernanke, Yellen and Dudley — are the driving force of the Fed in terms of decision making, as is (Chicago Fed President Charles) Evans, so I think they will maintain control, so to speak," Gross said on "Street Signs." "But the surprise is there's a little more dissension than we saw beforehand."

Gross said he favors the short end of the Treasury market, while the Fed targets the longer-duration securities.

"So if quantitative easing were to end, it would be the long bond that would suffer the most," he said. "I don't anticipate that in 2013 or in 2014."

Gross also said PIMCO and other investors expect the Fed to change policy when its new monetary targets—6.5 percent unemployment and 2.5 percent inflation—are within reach.

At the December meeting, the Fed extended its monthly purchases of Treasury securities, which were to have stopped at year-end with the expiration of a program called Operation Twist. The twist program involved the purchase of longer dated Treasurys and the sale of the same amount of shorter duration Treasurys, so as not to expand the Fed's already stretched balance sheet.

The Fed's asset purchases total $85 billion a month, and included the purchase of mortgage securities as part of an open-ended quantitative easing program, or QE3.

The Fed's minutes read:

"In considering the outlook for the labor market and the broader economy, a few members expressed the view that ongoing asset purchases would likely be warranted until about the end of 2013, while a few others emphasized the need for considerable policy accommodation but did not state a specific time frame or total for purchases. Several others thought that it would probably be appropriate to slow or to stop purchases well before the end of 2013, citing concerns about financial stability or the size of the balance sheet. One member viewed any additional purchases as unwarranted."

"It's less dovish than people expected," said Win Thin, senior currency trader at Brown Brothers Harriman. "The Fed is buying at a pace of a trillion dollars a year. It becomes harder and harder to reverse, so I have sympathy for that."

Ward McCarthy, chief financial economist at Jefferies, said the Fed managed to confuse markets, but the bond market could become a bit more anxious about the future of the asset-purchase program.

"It makes you wonder," said McCarthy. "The Dec. 12 statement made it appear some things were set in stone for quite some time, and this muddles the picture more than clarifies it. There have been obviously fissures for quite some time, and there were always different opinions at the Fed. … My point is the connection between the minutes and what they did in December is not as tight as I would have expected. It makes me wonder. It leaves a lot of unanswered questions."

As for the bond market, it will become more obsessed with the state of the economy. "I think it will reduce the market's tolerance for sequentially improving data," said McCarthy, adding an improving economic picture would lead to higher interest rates.

Traders could also become more focused on gaming the Fed with each report.

Art Hogan of Lazard Capital said he sees the Fed's comments as healthy. "Anyone who thought the E in QE is 'eternity,' then they're wrong. It's healthy to have this debate. You don't want this to go on forever. You want balance to come back to the Treasury market. You don't want to have just one buyer."