Call it a "dovish tightening."
That's the jargony phrase that might best describe how many economists and traders are viewing this week's meeting by the central bank on where to set U.S. interest rates.
"Tightening" refers to the likely decision by Fed Chairman Jerome Powell and other members of the Federal Open Market Committee to raise the benchmark U.S. short-term borrowing rate for the fourth time in 2018; over the past two years, the central bank has raised rates at a pace of 0.25 percentage point per quarter. Powell has described it as "gradual."
And based on trading in futures markets on the Federal Reserve rate, there's a 73% chance that the central bank will maintain that pace when it makes its announcement around 2 p.m. today, boosting benchmark interest rates by 0.25 percentage point to a range between 2.25% and 2.5%.
But "dovish" refers to the heightened speculation in recent weeks that Fed will signal -- in a statement accompanying the rate decision -- that it could pause or halt the rate-hiking campaign early next year. When a central bank turns dovish, it goes soft on interest rates, giving borrowers a break on their debt payments while accepting the risk that the economy might heat up, causing inflation to accelerate out of control.
According to Daniela Mardarovici, a portfolio manager of Bank of Montreal's $1 billion BMO TCH Core Plus Bond Fund, the Fed may scrap its recent pledge to continue raising rates at a gradual pace, while also flagging the increasingly challenging "financial conditions" in global markets.
The Fed may also release updated economic projections showing that officials now expect to boost interest rates twice next year, instead of the three times called for in the last update, released in September, she said.
Although the Fed is supposed to set rates in a way that maximizes employment and keeps inflation in check, the central bank also monitors what's happening in global markets. That's because lower stock prices can affect business leaders' decision on whether to invest in new factories and equipment, while also hurting confidence among individual investors who have suffered declines in their stock portfolios and retirement accounts -- and by extension, their wealth.
The fear is that a bunker mentality develops, hampering economic activity and slowing growth. The Standard & Poor's 500 Index of large U.S. stocks has tumbled 12% in the past three months, even though the unemployment rate is at a half-century low of 3.7% and inflation isn't showing any signs of spiking.
"We are experiencing a small microcosm of how financial conditions can really affect the outcome of Fed policy and translate into the real economy," Mardarovici said. "A risk-averse behavior in the markets can translate to risk-averse behavior among business participants as a whole, as well as among consumers."
President Donald Trump has blamed Powell for raising rates too quickly, saying that the Fed's campaign is undermining the health of the U.S. economy. It's possible that the president is just seeking to deflect the blame away his own economic policies -- especially now that the stimulus is fading from his $1.5 trillion of tax cuts, which have caused the federal government's budget deficit to widen and contributed to the rapidly ballooning national debt.
But it's also possible that Trump might be right.
The stock decline has been fueled by concerns that the president's trade battle with China could lead to a global slowdown, but also by speculation that the economy may not be strong enough to handle higher borrowing costs. Gross domestic product is forecast to slow in 2019 to 2.5%, from an estimated 2.9% this year, according to a FactSet survey of economists.
The Wall Street Journal wrote Monday in an editorial that "economic and financial signals" suggest that Powell should pause the rate-hiking campaign this week.
"Get the monetary policy that best serves the economy, and the politics will work itself out," the editorial read. "Get the policy wrong, and Mr. Trump will be the least of Mr. Powell's political worries."
At a closed-door meeting in November, Fed officials discussed whether they might soon need to revise their pledge for "further gradual" rate increases, according to minutes of the discussion.
"Such a change would help to convey the committee's flexible approach in responding to changing economic circumstances," according to the minutes.
And in a recent speech, Powell himself said that interest rates, currently set in a range of 2% to 2.25%, were "just below" the broad range of estimates of a level that would be neutral for economic growth. The verbiage marked a shift from his comment in early October that rates were "a long way from neutral."
Turning dovish, as it were. But still tightening -- for now.