What Will the Fed Do Next?

What will the cognoscenti be looking for Wednesday when Federal Reserve officials release the results of their latest policy meeting and their updated economic forecasts – and Janet Yellen holds her second press conference as Fed chair?

No big change in policy is likely. The Fed probably will continue to pare the size of its monthly bond-buying by $10 billion and vow to keep interest rates low as long as the labor market is weak and inflation is below its target. You can see the data on inflation and unemployment at which the Fed is looking on the Hutchins Center’s new “Janet Yellen’s Dashboard.”

So most of the focus Wednesday will be on what the Fed says rather than what it does.

In the Federal Open Market Committee’s end-of-meeting statement, one key is how Fed policymakers view incoming data on the U.S. economy.

My Hutchins Center colleague Don Kohn, the former Fed vice chair who is now a senior fellow in Economic Studies at Brookings, says, “I will be paying a lot of attention to the first few paragraphs of the announcement where the FOMC characterizes the incoming data and its outlook for the future. Those are now the ingredients of qualitative guidance. Both unemployment and inflation are closer to the FOMC’s objectives than it probably expected. How do they evaluate that progress? Are they more confident about continued progress?”

Then there’ll be the now famous “dots,” the forecasts that individual Fed policymakers make (before the meeting) for economic growth, unemployment, inflation and interest rates (these are the dots) over the next three years – and in the longer run. The FOMC statement gives the consensus, but the individual forecasts reveal, among other things, when each committee member expects the Fed to raise short-term rates and how quickly. The Fed doesn’t identify which dot goes with which official, though, and reading the dots this time will be tricky because one Fed governor who was there in March has left (Jeremy Stein) and two new ones have arrived (Lael Brainard and Stanley Fischer) and a retirement brings a new president of the Cleveland Federal Reserve Bank.

The big conundrum: The unemployment rate is coming down and inflation seems more likely to rise than fall, all of which could quicken the day that the Fed tightens; but the mounting pessimism about the long-term growth outlook argues for keeping rates lower than has been usual when unemployment and inflation return to normal.

And then Yellen will elaborate on all this, and more, in her quarterly televised press conference. That gives her a chance to underscore some parts of the FOMC statement at the expense of others.

But I’ll be listening carefully to see what she says about the recent eerie tranquility in the financial markets – very little volatility, rising stock prices and shrinking spreads between the yields on risky bonds and safer ones. The possibility that markets are under-appreciating the risks is on the minds of Fed officials, as The Wall Street Journal’s Jon Hilsenrath has reported.

There’s not enough worry about the markets to provoke a precipitous move by the Fed to raise interest rates before the job market is healthier, but the press conference gives Yellen a high-profile opportunity to warn investors against complacency, if she chooses to do so.