Federal Reserve could offer clues to rate hike at this week's meeting

The Federal Reserve's message for the market this week could contain hints about the timing of its first interest-rate rise that echo the advice once offered in an old teen love song popular in the 60s: “See You in September.” With the central bank widely expected to hold policy steady at this week's meeting, Fed watchers are looking to the statement it issues on Wednesday for clues on when liftoff will occur. By changing their assessment of the economy and the risks it faces, Chair Janet Yellen and her colleagues could suggest the central bank is closing in on its first rate increase since 2006, perhaps as early as the following meeting Sept. 16-17. “I could see very small tweaks to the language that could indicate that liftoff is on track for September,” said Jonathan Wright, a professor at Johns Hopkins University in Baltimore and a former economist at the Fed's Division of Monetary Affairs. Economists surveyed by Bloomberg put the odds of a September rate increase at about 50%. Policy makers have held their target for the fed funds rate — which commercial banks charge each other for overnight loans — at zero to 0.25% since December 2008. The last time the Fed began a tightening cycle, back in 2004, it plainly signaled its intentions beforehand by stating that increases would occur at a “measured” pace. Economists don't anticipate anything as unambiguous as that this week. “I'm not expecting a very clear signal,” said Roberto Perli, a former Fed economist who is now a partner at Cornerstone Macro in Washington. DATA DEPENDENT After all, Fed officials from Ms. Yellen on down have made clear that they're not enamored with the measured-pace language of 2004 and also have gone out of their way to stress that their policy decisions will be “data dependent.” What's more, a slew of data that policy makers might want to see before deciding on a rate move — including reports on second-quarter gross domestic product and the employment cost index — won't be released until after this week's meeting. Still, it's not in the interest of the Federal Open Market Committee to mislead the markets, said Dana Saporta, a U.S. economist at Credit Suisse in New York. “If the FOMC is planning to tighten in September — and I think that is the base case — I think they will consider adjusting the guidance” on rates this week, she said. The best way for policy makers to do that would be to change their characterization of the risks facing the economy, according to Drew Matus, deputy chief U.S. economist for UBS Securities in New York. RISKS BALANCED In the statement issued after its June 16-17 meeting, the FOMC said it continued to “see the risks to the outlook for economic activity and the labor market as nearly balanced.” If policy makers shifted that assessment in the direction of “being biased toward growth,” that would heighten the chances they'll move in September without locking them in, Mr. Matus said. In a July 24 note to clients, JPMorgan Chase & Co. chief U.S. economist Michael Feroli saw a “good chance” that the Fed will describe the risks this week as just balanced rather than “nearly balanced.” Such a change would imply the Fed was making progress in healing the economy and getting closer to raising rates, without committing to a September move, he said. Mr. Feroli, who expects “no clear signal” on liftoff timing in the statement, said policy makers probably will indicate that they are nearing their goal of full employment by sounding more upbeat on the labor market. In its last statement, the FOMC said the data suggested that “underutilization of labor resources diminished somewhat.” Since then, the government reported that the jobless rate fell to a seven-year low of 5.3% in June as employers added 223,000 workers to their payrolls. A measure of underemployment watched by Ms. Yellen fell to 10.5% in June from 10.8% in May. The next two jobs reports — for July and August — are “probably the most important” indicators in the Fed's decision on whether to raise rates at its September meeting, said Jennifer Lee, a senior economist at BMO Capital Markets in Toronto. Mr. Wright said he expects changes to the Fed's description of the economy to be modest given that GDP looks to have grown at an annual pace of about 2.5% in the second quarter. That follows what is currently reported to have been a 0.2% contraction in the first three months of 2015. Since the recession ended in June 2009, GDP has expanded by an average 2.2% per year. Meanwhile, inflation looks like it has bottomed out, Mr. Perli said. Excluding food and energy costs, the personal consumption expenditure price index ran at a three-month annualized pace of 1.6% in May, double its rate in January, based on data from the Commerce Department in Washington. The Fed's target for inflation is 2%. OIL, DOLLAR There are two wild cards in the inflation outlook: oil and the dollar. In their last statement, policy makers said “energy prices appear to have stabilized.” Since then, Brent crude has fallen by about 14%, in part on expectations that supplies from Iran will increase following that country's nuclear deal with the U.S. and other major world powers. A slowdown in China also has played a role in the recent decline of oil and other commodity prices. The plunge in oil prices has reinvigorated bond bulls, and U.S. debt posted a second week of gains last week. That's after yields climbed for three straight months. The dollar has risen around 3.5% since the June FOMC meeting and is close to its highest level in more than 10 years, according to the Bloomberg Dollar Spot Index. A stronger dollar lowers prices of U.S. imports and puts downward pressure on inflation. Putting it all together, Mr. Wright said he expects the FOMC statement to “continue to indicate liftoff this year, but preserve flexibility on timing.” Traders are pricing in a 40% probability that the Fed raises rates in September, based on the assumption that the effective federal funds rate will average 0.35% after liftoff. That's the median estimate of the 22 primary dealers surveyed by the New York Fed. Mr. Wright looks for a September increase, but said that depends on data yet to be seen: “Between now and then, we get two employment reports, more inflation data, GDP numbers and time for developments in China to evolve.”