When the Federal Reserve ends its policy meeting Wednesday, many investors expect it to announce a shift in course. What they don't want are any surprises.
Pretty much everyone expects the Fed to take its first step toward slowing the economic stimulus it's supplied since the financial crisis and the Great Recession swept through the economy five years ago.
Yet it's also assumed the Fed will do so gingerly: with a small cut in its monthly Treasury and mortgage bond purchases - from $85 billion to perhaps $75 billion. Those purchases have helped keep long-term loan rates ultra-low to encourage borrowing and spending.
The Fed is also expected to stress that while it's slowing its bond purchases, it plans no change anytime soon in its benchmark short-term rate. It's kept that rate at a record low near zero since 2008. Investors will be watching for anything the Fed says about this rate, which affects rates on countless business and consumer loans.
Here's what to look for from each of four key events Wednesday: a statement the Fed will issue when its two-day meeting ends; the Fed's updated economic outlook; Chairman Ben Bernanke's news conference; and the reaction of investors:
This is where the Fed would announce its first slowdown in bond purchases. Many economists expect the cut to come entirely from the Fed's $45 billion a month in Treasury bond purchases. That would leave untouched its $40 billion a month in mortgage bond purchases.
The reasoning: The mortgage bond buying is intended to keep downward pressure on mortgage rates. The Fed likely doesn't want to diminish its support for the housing market, whose gradual but steady comeback has been a pillar for the U.S. economic recovery.
The statement is also where the Fed could strengthen its commitment to keep its key short-term rate at a record low. In December, the Fed began saying it expects to keep this rate near zero at least until unemployment falls to 6.5 percent - as long as the inflation outlook remains mild. Unemployment is now 7.3 percent. And in the past 12 months, consumer prices are up 1.5 percent, below the Fed's 2 percent inflation target.
The Fed could stress anew that 6.5 percent unemployment is merely a threshold, not a trigger, for any rate increase. Which means it might choose to keep the benchmark rate at a record low for an extended period even after unemployment has dipped below 6.5 percent.
That's especially true if unemployment is dropping mainly because more people have stopped looking for work, rather than because employers are hiring lots of people. The government doesn't count people as unemployed once they stop looking for a job.
This is one of four meetings each year when the Fed updates its economic outlook, based on individual forecasts of board members and regional bank presidents. It's likely to downgrade its outlook as it takes account of reality: The U.S. economy hasn't grown as fast this year as the Fed had expected.
In their previous forecast three months ago, Fed officials predicted that the economy would grow between 2.3 percent and 2.6 this year and between 3 percent and 3.5 percent next year. Most economists think the economy will have grown 2 percent - at best - this year and roughly 2.6 percent next year.
The Fed will update its forecasts for unemployment and inflation, too.
Besides updating its outlook for 2013, 2014 and 2015, the Fed will offer its first economic predictions for 2016.
These numbers will be watched for any hint that the Fed has grown more or less optimistic. More optimism could mean the Fed feels the economy could handle future rate increases relatively soon. Less optimism could signal that any rate increases remain further off.
Bernanke News Conference
This will be a major event - and not just because it will likely follow the Fed's announcement of a pullback in bond buying. It's also Bernanke's next-to-last news conference as chairman before his term ends on 31 January. (His final news conference will follow the Fed's last meeting of the year in mid-December.) Early this week, Lawrence Summers withdrew from consideration for the chairman's job, leaving the Fed's vice chair, Janet Yellen, as the leading candidate. Obama could announce his choice later this month.
As always, Bernanke will use his news conference to try to clarify any decisions the Fed announces. He's surely hoping for a more positive response than he drew at his June news conference. There, he said he'd been "deputized" by his colleagues to describe a possible path toward slowing the bond purchases. Bernanke said the slowdown would likely start before year's end and be completed by mid-2014.
He stressed that any Fed moves to scale back its support would hinge on how the economy fares. But investors didn't hear such assurances. They responded in panic to the prospect that the Fed would soon reduce its support for the economy. The Dow Jones industrial average sank 560 points in two days.
Investor response to a pullback in bond purchases is expected to be mild if the Fed announces a slight reduction of around $10 billion a month. That's particularly true if the Fed balances its move by underscoring its commitment to keep its benchmark rate low far into the future.
Economists generally think the Fed has done enough, through comments from Fed officials, to prepare the markets for the start of a modest and gradual reduction in bond purchases.
Yet if the Fed's initial move to trim the purchases is larger than investors expect, watch out. The reaction could be turbulent. And if the Fed surprises everyone and decides against trimming its bond purchases at all?
The markets may just rally.
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Updated Date: Dec 21, 2014 00:13:29 IST