Fed Officials Still Tinkering With Exit of Bond-Buying Program

Federal Reserve officials have mapped out a strategy for winding down an unprecedented $85 billion-a-month bond-buying program meant to spur the economy--an effort to preserve flexibility and manage highly unpredictable market expectations.

Officials say they plan to reduce the amount of bonds they buy in careful and potentially halting steps, varying their purchases as their confidence about the job market and inflation evolves. The timing on when to start is still being debated.

The Fed's strategy for how and when to wind down the program is of intense interest in financial markets. While the strategy being debated leaves the Fed plenty of flexibility, it might not be the clear and steady path markets expect based on past experience.

Officials are focusing on clarifying the strategy so markets don't overreact about their next moves. For example, officials want to avoid creating expectations that their retreat will be a steady, uniform process like their approach from 2003 to 2006, when they raised short-term interest rates in a series of quarter-percentage-point increments over 17 straight policy meetings. "I don't want to go from wild turkey to cold turkey," Richard Fisher, president of the Federal Reserve Bank of Dallas, said in an interview Friday. "I think we ought to dial it back." Mr. Fisher is part of a contingent of Fed hawks who are wary of the central bank's easy-money policies. Stocks and bond markets have taken off since the Fed announced in September that it would ramp up the bond-buying program, and major indexes closed at another record Friday. An abrupt or surprising end to it could send stocks and bonds in the other direction, but a delayed end could allow markets to overheat. And some officials feel they've ended other programs too soon and don't want to repeat the mistake. The Fed's strategy on how to unwind the program has emerged as a source of some uncertainty in markets in the wake of its policy meeting earlier this month. The Fed said in its postmeeting statement that it was "prepared to increase or reduce the pace of its purchases" as the economic outlook evolved. The suggestion that the Fed might boost its bond buying was a change in the policy statement that seemed to some an acknowledgment that more aid for the economy might be needed. Employment data in April were weak and inflation has fallen well below the Fed's 2% inflation objective, both points that allow leeway for more stimulus. But many officials believe the recovery is on track and aren't yet concerned about the inflation slowdown. Instead, the most recent statement seems more aimed at signaling the Fed's broader flexibility in managing the programs. Charles Plosser, president of the Philadelphia Fed, said in an interview Friday that the change in the statement was meant "to remind everybody" that the Fed has "a dial that can move either way." The dial can also pause. Fed officials could shrink the size of their purchases and hold it at that level for a while as they assess the effects, or they could make several moves in a row if that seemed right. They could also boost their buying if they lose confidence about the economic outlook. The strategy is meant in part to ensure flexibility in an uncertain economy. Yet while officials appear increasingly settled on a strategy for how to dial back the program, they haven't decided when to start. Mr. Fisher said he advocated starting right away at the last Fed meeting. Some officials can envision taking a first step this summer, if strong data show the economy is weathering the tax increases and federal spending cuts that appear to be weighing on growth. But they might wait longer, especially if the economy disappoints, as it has for several years during the spring and summer months. A Wall Street Journal survey of private economists this week showed that 55% expect the Fed to start shrinking its bond purchases in the third or fourth quarter this year, while 45% expect the Fed to wait until next year or later. None expected the Fed to increase its purchases as its next step. The bond-buying programs are aimed at pushing down long-term interest rates and boosting financial markets to encourage more borrowing, spending and hiring in the broader economy. The Fed's securities holdings have increased from $2.58 trillion to $3.04 trillion since September. Clearer signals about the Fed's plans could emerge next week. Five regional Fed bank presidents, including Mr. Fisher and Mr. Plosser, and Fed Governor Sarah Bloom Raskin are scheduled to speak. Fed Chairman Ben Bernanke will discuss economic prospects for the long-run in a commencement address at Bard College in New York next Saturday, May 18. Central-bank officials want to see substantial improvements in the job-market outlook before the programs are ended all together. And then, efforts to boost short-term interest rates might not occur for months or even years later. The unemployment rate has fallen to 7.5% from 8.1% in August, both because of hiring and people leaving the workforce. Payroll employment has increased on average by 193,000 per month during the eight months since the program was launched, compared with average gains of 157,000 before it began. "It is pretty hard to say we haven't seen an improvement in the labor market," Mr. Plosser said. Many economists believe economic growth will slow in the second quarter--in part because of fiscal drags-from a 2.5% annualized rate in the first quarter, but then accelerate in the second half. If growth remains firm in the weeks ahead that could give officials more confidence about starting to pull back. Fed officials aren't very concerned about the annual rate of inflation falling toward 1% in recent months, well below their 2% objective. Because expectations of future inflation have remained steady, many Fed officials expect inflation readings to move back up toward 2% in the second half of the year. "I'm not too worried about it," Mr. Plosser said. "Expectations remain pretty stable." The Fed has policy meetings in June, July and September, and Mr. Bernanke will have a chance to explain its actions at news conferences in June and September. Some of the bond-buying program's most vocal proponents have signaled more optimism about the outlook and a willingness to consider pulling back from the programs. John Williams, president of the Federal Reserve Bank of San Francisco, said in an interview last month that he anticipated pulling back this summer. "I'm looking for continuing signs of improvement in the economy," he said, "sustained, ongoing improvement in the economy." Write to Jon Hilsenrath at jon.hilsenrath@wsj.com