The majority of big banks that deal directly with the Federal Reserve are confident the central bank can exit from its unorthodox policies, though they don't expect the Fed to have to raise rates until 2010 or later.
Federal Reserve Chairman Ben Bernanke and other central bank officials have gone to great lengths to reassure markets the U.S. central bank has the tools needed to control monetary policy and avert inflation once the economic recovery picks up steam.
Bernanke last month detailed these tools in a monetary policy report to Congress as well as in an op-ed essay in The Wall Street Journal.
His efforts seem to have paid off: eight out of 14 primary dealers that are members of the Fed's exclusive 18-strong network said they were confident in the Fed's exit strategy, four said they were very confident and just two said they were not very confident.
Goldman Sachs and Deutsche Bank did not respond to the poll, Morgan Stanley and UBS did not respond to the exit strategy question. For the full responses, please see the table below.
We are confident that they know how to exit, but a bit less confident that they will do so in a way that prevents inflation from rising in the medium term, said Dean Maki, head of U.S. economic research at Barclays Capital.
The Fed has cut interest rates to near zero, bought longer-term Treasuries and mortgage-related debt and put in place a number of emergency lending facilities in its fight against the worst financial crisis since the 1930s.
Federal Reserve policy-makers have said that they will keep rates low for some time, and New York Fed President William Dudley last month said it was very premature to talk about the timing of a policy reversal as economic strains remain.
Eleven of the sixteen primary dealers polled expect the Fed to raise interest rates next year, three said 2011 and two said the Fed would keep rates near zero until 2012.
That's even as 15 out of 16 dealers say the first quarter of positive economic growth will occur in the third quarter of this year.
There have been some signs that the worst of the recession is past. On Friday, the Labor Department said U.S. unemployment rate fell in July for the first time in 15 months as employers cut far fewer jobs than expected, providing the clearest sign yet that the economy was turning around.
Seven out of 15 primary dealers see unemployment peaking in the fourth quarter of this year, and eight see it peaking in the first half of 2010.
Fed officials meet on Tuesday and Wednesday to review the outlook for growth. They are expected to reinforce their message of no imminent exit from bold policy steps to end the U.S. recession, while opting not to prolong Treasury buying.
Remarks by Fed officials, together with indications that the economy is starting to stabilize, have cut the chances that the central bank will expand its program to buy up to $300 billon in longer-dated Treasuries.
Fourteen out of 16 dealers polled said they do not expect the Fed to expand its Treasury purchase program.
The benefits of the program haven't obviously outweighed the costs, said Bob DiClemente, chief U.S. economist at Citigroup.
But 13 out of 15 dealers expect the Fed to extend its program to revive consumer, small business and commercial real estate lending beyond its December expiry date.
Those markets are getting better, but we are definitely not in a position where the Fed can back away from nursing them along, said DiClemente.
The New York Fed's Dudley said in a question and answer session last month that the Fed will be soon be evaluating whether or not to extend the Term Asset-Backed Securities Loan Facility (TALF).
The TALF is authorized under a section of the Federal Reserve Act only when conditions are deemed unusual and exigent, he noted, and the Fed would have to determine whether these conditions still exist in those markets and for how long they are likely to last.