Dissent in the Fed: An Early End to QE?

With $85 billion in quantitative easing flowing into the Federal Reserve already massive $3 trillion balance sheet, there is already widespread concern over the Fed's unprecedented actions. Now, there are strong signs that the Fed's board members are increasingly concerned as well.

According to the Federal Open Market Committee minutes for the January 29-30 meeting:

“Several participants emphasized that the Committee should be prepared to vary the pace of asset purchases, either in response to changes in the economic outlook or as its evaluation of the efficacy and costs of such purchases evolved. For example, one participant argued that purchases should vary incrementally from meeting to meeting in response to incoming information about the economy. A number of participants stated that an ongoing evaluation of the efficacy, costs, and risks of asset purchases might well lead the Committee to taper or end its purchases before it judged that a substantial improvement in the outlook for the labor market had occurred.”

This would be a large departure from the status quo. Currently, the Fed is targeting changes to its QE programs if and when unemployment hits a 6.5% rate and inflation stays under control. With official unemployment at 7.8% and the number of potential workers without jobs more than double that rate, QE was expected to keep up its current pace well into 2014 at the earliest.

At the December meeting, Fed officials were about evenly divided between those favoring a mid-2013 end to purchases and those advocating a later date. Now the debate has shifted to how to wind down the programs instead of just discussing when they should hypothetically end.

Fueling the dissent from Ben Bernanke's position on the matter is rising concerns about asset bubbles, financial instability and the long-term potential for hard to control inflation.

A massive influx of investment in corporate and junk bonds is fueling fund managers and economists to question the scope of QE programs. These bonds depend on low interest rates to remain profitable. Any interest rates change could erase gains for investors or lead to a massive correction that would drive bond investments sharply down.

With markets hitting five-year highs and approaching all-time highs during a period of financial and economic uncertainty, the worries about asset bubbles are certainly justified. Easy money being funneled into the markets may continue to push equity investments beyond sustainable and reasonable levels and fuel another massive correction or crash.

Long-term inflationary pressures are quite an issue as well. With $3 trillion locked up through Treasury andmortgage-backed security purchases on the books -- enough to pay for the entire 2009 Federal budget -- it will take a long time to unwind and reduce the holdings.

If the economy heats up, what would be a positive change would backfire because the Fed may have removed its ability to keep inflation in check for many years to come.

All of this is finally starting to weigh on the Fed's board members and they are increasingly supporting changes to reduce quantitative easing. Better late than never.

Charts courtesy of The Wall Street Journal.