"Quantitative easing (QE) could be upsized," says Brian Smedley at Bank of America Merrill Lynch. Such a move would be a response to signs that the US economy is slowing down. Latest figures show that manufacturing output and retail sales both fell last month, and that non-farm employment grew at its slowest rate since June. This suggests that the sequester - automatic cuts in government spending - is hurting general economic activity. And with China growing only slowly and the eurozone still in recession - purchasing managers this week reported yet another fall in activity - there's little hope that exports can raise US growth.
What's more, says Mr Smedley, the combination of slower growth and lower commodity prices has reduced inflation expectations; the 10-year break-even inflation rate (the gap between Treasury bond yields and their inflation-proofed counterparts) has fallen to a seven-month low. This gives the Fed more room to stimulate the economy.
Expanding the QE programme risks inflating what many believe to be a 'bond bubble'. If the Fed increases its buying of Treasuries from the current $45bn a month to $65bn, as Mr Smedley thinks possible, then it could finance the entire US budget deficit - which is expected to be $612bn this year. Given that there is strong foreign demand for US Treasuries - overseas buying has recently been over $20bn a month - this could drive medium-term bond yields down even further, and drive asset prices generally upwards as private savings look for different investment vehicles.
But Brian Reading at Lombard Street Research says that US Treasuries are already "artificially priced" because so many are held by central banks and sovereign wealth funds for what he calls "non-market reasons"; overseas investors own $5.7 trillion of the US government's $11.9 trillion debt. With the deficit being funded by the Fed, such artificial pricing might intensify.
A further problem is that increasing the dose of QE will increase the difficulty of withdrawing the medicine when the economy strengthens. This will add to uncertainty about asset allocation not just over the timing and scale of QE's reversal, but also about how the economy would respond to such a reversal. Russell Jones at Llewellyn Consulting says that when QE ends, "asset prices will lose an important source of support".
