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Fed to hold rates steady to reassess outlook: Decision-day guide

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Federal Reserve officials convene this week amid expectations that they will take a break after their December interest-rate hike to assess whether the economy is shifting out of its low-inflation, 2 per cent growth mode into a higher gear.

[WASHINGTON] Federal Reserve officials convene this week amid expectations that they will take a break after their December interest-rate hike to assess whether the economy is shifting out of its low-inflation, 2 per cent growth mode into a higher gear.

Following the election of President Donald Trump, both household and business sentiment indicators have jumped. US central bankers are watching closely to see if the rising confidence is being met with action in the form of stronger investment spending, continued hiring and increased compensation.

In the meantime, they're expected to keep interest rates on hold at the conclusion of their two-day gathering in Washington on Wednesday and be careful not to make a clear commitment on the timing of the next hike in their policy statement released at 2 pm. There is no post-meeting press conference scheduled with Chair Janet Yellen.

Of course, it is too early to see much of any influence from Trump proposals in real economic data just yet.

Survey measures of business conditions and confidence are up with the Conference Board's measure of consumer attitudes coming off a 15-year high and the National Federation of Independent Business's optimism index at the loftiest levels since 2004. Actual economic activity has yet to catch up. Fed officials must figure out how new policies add or detract from growth. Tighter immigration rules could slow a needed expansion of the labor force. Deregulation and tax reform could boost business investment. For the Fed, uncertainty is higher.

Investors see a less than 15 per cent probability of a rate hike when the policy-setting Federal Open Market Committee meeting concludes, according to pricing in federal fund futures contracts. That compares to a roughly 30 per cent likelihood at their March meeting, rising to around a 70 per cent chance by the June FOMC. Fed officials projected three quarter-point rate hikes this year, according to the median of their latest estimates.

Still, that doesn't mean the biggest change in the FOMC statement will be the date at the top of the page. The lead paragraph of the statement will have to be updated to reflect recent reports on economic growth, employment and inflation.

Since the unemployment rate rose a 1/10 a per cent in December to 4.7 per cent, the committee will need to rephrase part of the statement's opening paragraph to describe the unemployment rate as low, instead of "has declined," notes JPMorgan Chase & Co.'s Chief US Economist Michael Feroli in a note to clients. Business investment in equipment rose for the first time in five quarters in the final three months of 2016. That means the committee might revise the "has remained soft" language from December.

"The tone will be more upbeat on investments," said Thomas Costerg, senior US economist at Standard Chartered Bank.

Another phrase that is likely to come under review is the "roughly balanced" characterization of economic risks that has appeared in the last three FOMC statements.

"There is a small chance that you get a comment that risks are tilted to the upside," said Guy Lebas, chief fixed-income strategist at Janney Montgomery Scott in Philadelphia. "But the policy situation in Washington, while a bit chaotic, hasn't emerged yet to provide greater possibility of fiscal stimulus." The price index for personal consumption expenditures, Fed's preferred gauge of inflation, rose 1.6 per cent in the 12 months through December, its highest level since 2014.

With little reason to downgrade risks yet, and no evidence in hand to upgrade them, phrasing around risks to the outlook probably stays the same.

Four officials will rotate into voting seats on the FOMC this year. Patrick Harker, president of the Philadelphia Fed; Dallas Fed chief Robert Kaplan; Chicago's Charles Evans; and Neel Kashkari, president of the Minneapolis Fed, will all cast a vote on the statement language and whether to keep the benchmark lending rate in a range of 0.5 per cent to 0.75 per cent. Because the panel is not expected to hike rates or send a big policy signal, dissents don't look likely.

Finally, every January the FOMC has a series of votes on operations and strategy, including a statement of its longer-run goals for policy. This is where they reaffirm their commitment to the 2 per cent inflation target, which they have missed for more than 4 years. Last January, they modified the language to say that their objective was symmetric, noting that they would be "concerned if inflation were running persistently above or below" the goal. Changes to long-run strategy goals have a high hurdle and expectations are low for any modifications this time around.


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