Most expect the U.S. central bank to open the door to the first interest-rate hike since 2006 by removing language saying the Fed can be "patient" before raising rates because inflation is low and growth is soft.
But that move, expected when the Fed's statement is released at 2 p.m. EDT, only gives the Fed flexibility. Fed Chair Janet Yellen's press conference at 2:30 p.m. EDT will tell markets what the Fed will do with that maneuvering room.
"I think Dr. Yellen will take great pains in her presser to reinforce the point that removal of "patient" does not lock them into a rate hike in June, it simply makes them data-dependent," Regions Financial Chief Economist Richard Moody said. "Part of finessing the removal of 'patient' is convincing the markets the path of rate hikes will be very measured, not like historical rate hike cycles in which they raised the [federal] funds rate each meeting" after hikes began.
If it happens that way, it would let Yellen and company mark a middle path between the bullish picture of the economy being painted by recent jobs reports and the more-sluggish picture emerging from most other recent data.
As weak reports on retail sales at stores like Wal-Mart (WMT - Get Report), manufacturing for companies like General Electric (GE - Get Report) and Boeing (BA - Get Report), and home construction roll in, inflation has been trending even further below the Fed's 2% target. The drop in the unemployment rate to 5.5% hasn't yet been matched by broad-based wage acceleration, suggesting that the central bank may reduce its view of the economy's optimal jobless rate, Moody said. That would let policy makers take more time before raising rates if data don't perk up, he said.
Calls for caution were amplified by a Financial Times report that Bridgewater Associates' Ray Diallo had told clients of the world's largest hedge fund that the Fed would risk a 1937-like recession if it tightened too soon. In 1937, tightening both fiscal and monetary policy led to a less-severe relapse of the Great Depression, which didn't fully lift until the U.S. entered World War II in 1941.
There is still some chance the Fed will delay removing the "patient" language from the statement, said Bank of America Merrill Lynch (BAC) economist Michael S. Hanson, who expects the first interest-rate hike to come in September or later.
"We expect the Fed to use care as it takes out 'patient,'" Hanson wrote in a note to clients. "Guidance is likely to shift from the timing of liftoff to the pace of rate hikes. We look for two key messages in Yellen's press conference remarks that may also appear in the statement itself: (1) the Fed plans a gradual tightening cycle - notably more gradual than in the past - and (2) policy will remain highly accommodative even as rate hikes are underway."
For investors, that compromise between opening the door to higher rates and signaling a move may mean markets will have time to adjust, Hanson said. That reduces chances of a spike occurring as the markets scramble to catch up with a central bank that has long expected a quicker rebound in inflation and rates, than bond-futures investors have, he wrote.
The risk to markets is if the Fed botches communication, leaving it unclear how fast rate hikes might come, both Moody and Hanson said. If the Fed argues that the economy is strong and the recent dip in inflation won't last, it could cause markets to think a rate hike is coming sooner and bigger, Hanson wrote, risking a reprise of the big selloff when former Fed chairman Ben Bernanke said the central bank might begin winding down its policy of driving down rates by buying Treasury and mortgage bonds.
"The Fed does not want a repeat of the 2013 taper tantrum, so we look for some calming offsets between the statement, the Summary of Economic Projections, and Yellen's remarks to the press," Hanson wrote.
Bottom line: The patient language is likely to go, but that need not mean a June rate hike.