Fed Meets as Faith in Its Bond Purchases Wanes

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There's a wide divide on Wall Street over whether further bond purchases by the Federal Reserve can help lower interest rates, which have been rising since early May.

Economists, analysts and fund managers, who participated in the latest CNBC Fed survey, were almost evenly split on the question. Of the 60 respondents, 45.8 percent said further bond purchases could help lower yields, while 44 percent said they do not believe it would. Another 10.2 percent said they were unsure. More results of the survey will be reported Tuesday by CNBC Senior Economic Correspondent Steve Liesman, starting at 7 a.m. ET on CNBC's "Squawk Box."

The answer to the question on yields suggests that Wall Street is losing faith in the ability of the Fed's quantitative easing program to suppress rates. In April, 54 percent who answered the CNBC Fed survey said they thought QE could lower bond yields, while 35 percent did not.

(Read More: Stocks End Higher, but Fed Taper Talk Weighs; Dow Rallies 100)

The difference in opinion over whether the Fed's program is still helpful in lowering rates is understandable given the depth of the uncertainty about the program in financial markets, and the unease over when and how the Fed may begin to pare back on its $85 billion in monthly purchases. The bond market has been actively pricing in a tapering of the program, based on the comments from Fed officials, who have been changing market expectations for easing, whether intentionally or not.

Any whiff of what the Fed might do sends markets reeling. On Monday, for instance, stocks were up sharply on optimism the Fed will not yet signal that it plans to slow down bond purchases, but it then sold off quickly after a Financial Times report said that Fed Chairman Ben Bernanke is expected to say the Fed could begin to taper in several months, depending on the economy. That was basically what Bernanke has said himself in the past.

The selloff reversed when the writer of the article sent a tweet saying he had no special knowledge from inside Fed sources. The Dow ended up 109 points at 15,179, and the S&P 500 was up 12 at 1639.

(Read More: Futures Rally After Weekly Loss, Fed Meeting in Focus)

Many Fed watchers expect the Fed to begin cutting back on its purchases after the summer, with September a possibility, but others expect the Fed to wait until December, and still others don't expect tapering until 2014.

In the two months between CNBC's Fed surveys, Fed officials have talked about the idea of "tapering" down bond purchases. San Francisco Fed President John Williams, for instance, said the Fed could begin to taper its purchases as soon as this summer, if the economic data is strong enough. But what really swayed market thinking was a comment from Fed Chairman Ben Bernanke, who told Congress May 22 that the Fed could begin to reduce its purchases in the next couple of months if it sees sustained improvement in the economy.

The Fed begins its two-day meeting Tuesday and releases its statement and revised economic forecasts Wednesday. Bernanke also holds a press briefing Wednesday afternoon.

For weeks, traders have been handicapping what they think the Fed will do with its bond buying program, which is split between Treasurys and mortgage-backed securities. Expectations are high that Bernanke will give the market some clarity Wednesday on when or how the Fed will begin to trim back its asset purchases.

(Read More: Cramer on Speculation Fed May Taper Asset Buying)

"It's a pretty big expectation we're still going to get $85 billion in purchases after this meeting," said Tom Simons, money markets economist at Jefferies. "We've had all these uncertain developments in the last six weeks…in the absence of any specific guidance, (bonds would be) left unchanged or maybe even sell off a little bit because there's a real lack of confidence in the Fed's commitment to this program at this point."

Simons said if the Fed indicates it will taper sooner than expected, that would be bearish for bond prices, and yields would rise.

"They've been continuing to buy assets in the last month. We've seen rates since the beginning of May have jumped substantially," he said. "Mortgage rates are up 115ish basis points. The 10-year note yield is up 55 basis points, and that's while the Fed is buying."

(Read More: Here's What Is Benefiting From Fed Tapering Fears)

Ian Lyngen, senior Treasury strategist at CRT Capital, said his assumption is that Bernanke will mention tapering, but give no specific time frame. "That gets us to the base assumption which is September," he said. Many Fed watchers expect the Fed to draw out the wind down, reducing the purchases gradually and finishing it sometime next year.

If Bernanke says nothing about QE and tapering the program, that would be a negative for stocks, he said. "I think 'nothing about QE' is good for 10s and 30s. I think the non-tapering language would continue this bit of a reversal we've seen after 10-year yields made a push toward 2.30," he said. Lyngen said there are a lot of calls on the street to buy the 3-year and 5-year notes, but those are trades that benefit from the Fed's extended zero interest rate policy, which is not expected to change until 2015.

"The 10s and 30s section of the curve seems a lot more tapering dependent," he said.

Besides the Fed, markets Tuesday will be watching CPI inflation data and housing starts, both released at 8:30 a.m. ET.