The stock markets impressive rally of the recent days could hinge on the following question- How will the Fed exit from the implemented measures? This is indeed the $4 trillion question that faces the Fed at the moment. With increasing anxiety enveloping the markets, investors are seemingly anxious to know- what is the plan of the Fed for getting rid of all the government debt it has brought in an effort to stimulate risk assets and boost the economy. Will the Fed, with the world watching, take some stance with the inflation and thereby allow all the debt to mature in its stipulated time, or will it begin selling into the marketplace, risking losses that would stop the support payments it is sending to the nation’s Treasury vaults?

The Fed’s Open Market Committee will conclude its two-day meeting today but is unlikely to provide more hints about how it will end its bond-buying program, otherwise famously coined as quantitative easing. While the Fed has been able to furnish the information regarding the interest rates-with target of 6.5% unemployment and 2.5% inflation- the Fed has been more cautious in regards to its bond buying. The Fed’s caginess to divulge their plan for exiting has some of its members on the very edge, as a messy exit could strangle a market rally.

Analysts opine that the Fed has three choices:

• Either start narrowing its purchases;
• Hold the debt to maturity instead of selling it; or
• Pick and choose what it sells in hopes of timing the market correctly.

The Fed has created more than $3.2 trillion to buy $1.77 trillion in Treasurys, $1.02 trillion in mortgage-backed securities and a handful of other debt instruments. In addition, it is buying $85 billion a month in Treasurys and MBS, which would bring the total balance sheet to about $4 trillion by the end of 2013. Some economists, though, worry that the Fed will take losses on the debt and, at least for a period of time, have to halt the payments it sends to the Treasury on proceeds it gets in normal times from its holdings.

While the amount of those remittances used to be small, it has ballooned - along with the Fed's balance sheet - now to about $90 billion in 2012. Rising yields would be felt throughout the markets and corporate earnings in particular, which have been helped by cheap capital that companies have used to support their businesses. Those profits in turn have encouraged investors, who have been chased into the stock market as yields have evaporated on other debt instruments, even high-yielding junk bonds. Taken together, the Fed faces some difficult choices about how it will end its easing program without causing market havoc. Only time would tell on the market reaction of the Fed’s exit!