Fed Likely to Stay Cautious on Rate Forecast, Bank of America Says
Federal Reserve Chairman Jerome Powell.

With unemployment at a 17-year low and signs of inflation picking up, the Federal Reserve is proceeding, as expected, to raise U.S. interest rates.

Just not too fast.

Many economists now expect the central bank to raise rates three more times this year -- including an almost-certain quarter-percentage-point hike at the conclusion of a meeting on Wednesday. But Fed officials led by Chair Jerome Powell have stuck with their own average projection for just two more hikes, keeping markets on edge.

And that's unlikely to change when the Fed releases updated projections along with its rate decision on Wednesday, analysts at Bank of America Corp. (BAC) wrote Tuesday in a report. The caution stems from so-called "tail risks," according to the bank; that's economic jargon for severe risks like a global trade war or even a U.S. recession, either of which could derail the nine-year-long expansion.

"While the Fedspeak has brightened since the March meeting, we believe those who have priced in three hikes this year are likely to wait for more clarity on tail risks before shifting to four," the Bank of America analysts wrote. 

The Fed's caution on the rates forecast could provide relief to global markets, especially as the European Central Bank prepares to discuss potentially ending its own monetary-stimulus program at a meeting on Thursday. The Standard & Poor's 500 Index of large U.S. stocks rose 0.3% on Tuesday to a five-month high of 2,790. 

The central bank's current target for the benchmark U.S. interest rate is set in a range between 1.5% and 1.75%, so this week's quarter-point hike would increase that range to between 1.75% and 2%. Two additional hikes would take the rate to between 2.25% and 2.5% by the end of the year, but trading in December futures contracts shows that traders are pricing in a rate of just 2.175%.     

"The market doesn't believe what the Fed is doing until it says so," said Peng Zhou, managing director of derivatives and quantitative strategy at Sun Life Investment Management, which oversees about $45 billion.

The central bank's monetary-policy committee last raised rates at a meeting in March, its sixth hike since late 2015. For years, the Fed had kept rates close to zero to stimulate growth following the 2008 financial crisis.

Powell and other Fed officials have repeatedly pledged to raise rates "gradually" to keep the economy from overheating as President Donald Trump's tax cuts take effect, providing fiscal stimulus, at a time when labor markets are unusually tight.

The U.S. unemployment rate fell in May to 3.8%, the lowest since late 2000 but still above readings of 3.4% reached in the late 1960s and the record low of 2.5% from 1953. Low unemployment often leads to faster wage increases, a key driver of inflation.

The Fed's preferred measure of price increases has climbed to 2% in recent months, reaching the central bank's target faster than officials had projected. While high inflation is considered bad for the economy, Fed officials had been flummoxed in recent years by persistently low inflation, usually seen as a sign of a sluggish economy. 

"We expect Chair Powell to reaffirm the committee's view that the economy is evolving in line with their expectations and that it will warrant a gradual pace of hikes," the Bank of America analysts wrote.

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