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 The central bank has held short-term borrowing costs near zero for
seven years and the last thing policymakers want is for their first
rate hike to trigger expectations for future increases that could
knock economic growth off track.
Traders currently expect the Fed to raise interest rates two or
three times next year. Fed officials have used quarterly projections
to flag a slightly faster pace of increases, but fresh forecasts to
be released next week are expected to hew more closely to the
market's view.
The forecasts may also show policymakers are banking on slower
long-term economic growth and for interest rates to top out at a
lower level than was historically the case.
So while Yellen and her colleagues say their interest-rate decisions
will be "data-dependent," they are also keen to keep markets calm by
showing they see little need to jack up rates at the slightest hint
of economic overheating.
"I know that everybody says, 'will she or won't she,'" San Francisco
Fed President John Williams told reporters last week.
But "there's a whole path of rates for the next couple years.
There’s also the whole decision of how to communicate not only any
decision that we make — whether to raise rates or not –- but also
having to communicate, what does that mean for policy in the
future?", Williams said.
Just how the Fed will achieve this delicate balance is unclear,
although it will likely include critical tweaks to the language of
its post-meeting statement.
"Stronger forward guidance would be a good ingredient in next week's
statement, maybe not a calendar date but maybe about where the bar
is for the next move," said Carl Tannenbaum, chief economist for
Nothern Trust.
"If it’s phrased carefully, the markets will get a sense that,
absent a strong change in the fundamental results, it could be
mid-year before they move (again)."
A pause of three to six months between rate rises is consistent with
economists' expectations in a Reuters poll last Friday, after
employment growth boosted confidence that the Fed will raise rates
in December.
Yellen and other Fed officials have for months been suggesting that
rate rises, once begun, will be "gradual". Next week's statement
could be tweaked accordingly, rather than repeating the promise of a
"balanced" approach to rate increases in the statement from the last
meeting.
Yellen may have pointed to a second change in the statement in a
speech last week in New York, noting that the Fed will focus on
"actual progress" toward the Fed's 2.0 percent inflation goal as it
assesses how fast to raise rates.
Atlanta Fed president Dennis Lockhart recently signaled a similar
approach, flagging "direct evidence" of inflation rising as his
hurdle for future rate hikes.
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If incorporated into the Fed's statement, such a phrase could signal
a go-slow approach on rate increases, at least in the first half of
next year, since many economists currently expect falling oil prices
and a rising U.S. dollar to continue to keep inflation low in coming
months.
Once the effects of cheap oil and a strong dollar fade, the Fed may
have room to speed up rate hikes if needed.
FORWARD GUIDANCE
The Fed has used forward guidance effectively in the past, most
notably in 2011 when it explicitly promised not to raise rates until
at least mid-2013, a promise it later extended through mid-2015.
But a lot can go wrong as well. For example, Fed Chair Bernanke's
unexpected suggestion in 2013 that the central bank would soon
reduce its bond-buying resulted in market volatility.
Similarly, just a few months ago Yellen's comments about weak
economic growth in China convinced markets that the Fed would not
dare raise rates until 2016.
Importantly the Fed will next week release a new round of economic
projections that will help shape expectations for the pace of future
rate hikes just as much as the Fed's words in its policy statement.
The median projections in both June and September this year implied
four rate hikes over the course of 2016. Investors will watch those
projections closely for any change in that path.
"It is far from obvious that the Fed will tighten as fast as it is
suggesting today, so that markets might actually be right,"
Cornerstone Macro economists Roberto Perli said.
(Reporting by Ann Saphir; editing by David Chance)
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