Subprime's Salvation Is Fed's Conundrum

While traders want a rate cut and think it will help the market, a fed funds rate cut may only exacerbate inflation problems. "Liquidity does not come without inflation consequences," says Darda. Higher inflation certainly won't help the subprime borrowers suffering from higher loan payments or negative equity in their homes.

That said, the Fed is very aware that it must retain its credibility as being both thoughtful about economic concerns and vigilant on inflation, says Mickey Levy, chief economist at Bank of America.

Levy, like most economists, believes the Fed will keep its policy statement similar to recent offerings. "The Fed will give an honest read," says Levy. "They'll say the economy has softened a bit, but they'll maintain their upward risk assessment on inflation."

Any change in tone is likely to appear in the first or second paragraph of the statement -- where previous phrases have addressed changes in the economic outlook, such as "substantial cooling of the housing market" and "tentative signs of stabilization have appeared in the housing market." Don't expect the "boilerplate" language that has come at the end of every statement since last July's pause to go away:

The Committee judges that some inflation risks remain. The extent and timing of any additional firming that may be needed to address these risks will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information.

In other words, the Fed will keep its tightening bias. But the markets will probably read it as dovish and rally anyway.