At a two-day meeting opening Tuesday, the Federal Open Market Committee (FOMC) is unlikely to announce any backing away from its stimulative policy, but will probably be making contingency plans, say Fed watchers.

“The Fed is cognizant of the need to sop up excess liquidity when the economic recovery gains traction,” said Liz Ann Sonders, chief market strategist at Charles Schwab & Co.

Sonders and others point out that the Fed, which has lowered its base rate to near zero and pumped more than one trillion U.S. dollars into the financial system, must be prepared to act to avert a dangerous inflationary spiral.

“Inflation builds partly from fear,” she said.

“Consumers and investors need to believe that the extraordinarily bold monetary and fiscal policies unleashed during this crisis will be reversed. If they don't believe this, inflation expectations will soar — as will interest rates — and policymakers will be in a real bind.”

Peter Hooper, economist at Deutsche Bank, said the Fed and chairman Ben Bernanke face a delicate balance in preparing an exit strategy that does not choke off recovery.

“Having engaged in unprecedented conventional and unconventional monetary expansion, the Fed's exit problem will be more challenging than usual,” he said in a note to clients.

“The exit is already under way inasmuch as balance sheet expansion associated with the Fed's liquidity facilities has been running in reverse for a number of months now.

Many of these facilities will run down further but are likely to be kept in place until the Fed begins to raise policy rates.”

Still, the Fed will probably avoid any mention of a reversal, said Scott Brown, chief economist at Raymond James & Associates.

“Some say that the Fed needs to start unwinding its accommodative policy now to prevent future inflation. Others suggest that the economy is beginning to recover on its own and doesn't need the large fiscal stimulus and the higher deficits that entails. Such talk is foolish,” Brown said.

“Federal Reserve officials are confident that monetary policy accommodation can be scaled back in time to prevent inflation from rising too sharply. However, officials are also aware that many financial market participants aren't as confident in the Fed's ability to contain inflation.”

The Fed has already embarked on a massive program to purchase up to US$1.2 trillion in government and agency debt in an effort to bring down a variety of interest rates it does not control.

Bernanke calls the effort “credit easing” while others call it “quantitative easing.” It is aimed at lifting the economy out of its worst crisis in decades.

But a sharp rise in bond yields, which translates into higher lending rates for mortgages, has raised fears that the recovery could falter despite Fed efforts.

Julian Callow, economist at Barclays Capital, said that the shift in market interest rates should be viewed as a success story of the Fed, not a failure.

“Since the world is no longer priced for depression and deflation, the Fed's quantitative easing can be judged a major success,” he said.

“The easing had a major impact on equity market confidence: two-thirds of the 42 percent rally in global equity markets since the low on March 9 came in the wake of the March 18 FOMC announcement.”

Economists at UBS said the FOMC statement “will reflect a bit more optimism on the prospects for recovery but also a stronger signal that there will be no rush to unwind stimulus.”

They argued that “along with the potential for a quick unwinding of stimulus to undermine a nascent recovery, the likely downward pressure on inflation from slack will likely also encourage officials to be slow in tightening, notwithstanding criticism that the Fed was too slow to remove stimulus after the last downturn.”