With Fed Decision Nearly Certain, Attention Turns to Statement

For the first time in many months, there appears no doubt about the outcome of the Federal Reserve’s two-day policy meeting next week: Officials will almost certainly keep rates steady.

And amid uncertainty over the timing of any future rate increases, financial markets will scrutinize the accompanying statement even more than usual for any hint of the Fed’s intentions.

With officials striking a delicate balance between rising price pressures that argue for higher rates and a shaky economy that doesn’t, the tone of that statement may be best summed up with just two words: fingers crossed.

The Fed “is trying to buy some time,” said Paul Kasriel, chief U.S. economist at Northern Trust. “They’re going to try and word it in a way so as not to signal an imminent rate increase.”

J.P. Morgan economist Michael Feroli sees the FOMC reiterating that the Fed will resist an erosion of inflation expectations and stressing that any “unanchoring” would be a huge market setback. Still, while economists expect the statement to mirror the inflation rhetoric of late, they don’t expect anything drastic in the text.

Instead, the task for the Fed officials will be to highlight their inflation concerns, carefully — without suggesting that rate increases are imminent. Signs of consumer strength aside, the economy is still suffering. Recent economic data show accelerating weakness in the job market, with the jobless rate spiking 0.5 percentage point in May alone. At the same time, housing and manufacturing are still trying to overcome major challenges.

“I think they’re going to have to walk a fine line” between being cautious enough on the inflation front but not overly so, said MFR Inc. economist Joshua Shapiro, who sees the Fed holding rates steady “as far as the eye can see.” But overall, the statement will be “tilted towards more caution about inflation.”

The Fed can address those competing needs of emphasizing inflation vigilance without stressing markets with modest tweaks to its growth as well as inflation language, Fed watchers said.
Fed policymakers will probably describe economic conditions as weak or subdued as they have in the past, but also signal that the risk of a severe downturn has receded, which they haven’t done previously, economists said.

Chairman Ben Bernanke signaled as much on June 10, saying “although activity during the current quarter is likely to be weak, the risk that the economy has entered a substantial downturn appears to have diminished over the past month or so.”

As for inflation, expect officials to ratchet up their concern about the potential for higher food and energy prices to boost inflation expectations, Fed watchers said.

In their last two policy statements officials referred to rising inflation expectations, something they hadn’t done before in rate statements. Feroli thinks the Fed could send an even stronger signal with Wednesday’s statement that it won’t tolerate any further increase by stating that it will “strongly resist” any further erosion.

Officials will likely continue to forecast a moderation in inflation during the coming months as the slower economy eases pressure on labor and other resources. Indeed, though overall inflation as measured by the consumer price index spiked 0.6% in May, core prices that exclude food and energy rose a modest 0.2%.

But policymakers may drop April’s reference to a “projected leveling-out” of energy and commodity prices as a reason that inflation should moderate. They’ve been burned on that forecast many times, and Bernanke himself noted on June 9 that “futures markets quotes have underpredicted commodity price increases in recent years, leading to corresponding underpredictions of overall inflation.”

Fed watchers don’t expect the Fed to adopt a risk assessment between growth and inflation. It opted against doing so in April.

Wall Street will also eye the statement for any dissents. Only the first fed funds cut of the cycle, on Sept. 18, was unanimous. The last two decisions had two dissents each, from Philadelphia Fed President Charles Plosser and Dallas Fed President Richard Fisher. They preferred a smaller rate cut in March and none at all in April.

But it’s one thing to dissent from a rate-cut vote — after all, doing so firms up an official’s inflation-fighting credibility and may even help the Fed by signaling vigilance on prices. But after a while — and especially when the Fed is no longer cutting rates — dissents risk being viewed as no-confidence votes.

Still, Feroli sees at least one dissent in favor of a rate increase. “Maybe Fisher,” he said.