The FOMC will meet on Wednesday with the markets feeling confident that there will be no change in monetary policy. This means that the $85bn per month rate of balance sheet expansion will probably remain in place. But recently chairman Ben Bernanke has conceded, rather reluctantly, that the Fed’s exit strategy from quantitative easing will soon need to be reconsidered by the committee, and the debate could start at this month’s meeting. In any event, with economists now upgrading their forecasts for US GDP for the first time in quite a while, the markets are increasingly focused on whether the exit can be handled successfully.
The first question is whether the exit will be gradual or abrupt. The chairman’s personal preference is very well known: it should be gradual, and extremely well flagged in advance. But Mr Bernanke might not be in office after next January, and there are others on the FOMC who could have different ideas. Furthermore, economic and market circumstances could change. In 1994, GDP growth and inflation both rose markedly, and the Fed slammed on the brakes without any warning. The resulting 3 per cent rise in the Fed funds rate delivered a major shock to the financial system.