The Federal Reserve meeting: Five things to watch for

WASHINGTON -- The Federal Reserve’s last chance this year to reduce a key stimulus program comes Wednesday when central bank policymakers wrap up a two-day meeting and Chairman Ben S. Bernanke holds his last scheduled news conference before stepping down next month.

Recent upbeat economic data and a budget deal that promises to avoid another government shutdown in January have analysts speculating that the Fed could announce it will taper its $85 billion in monthly bond purchases.

But most observers put the odds of a Fed pullback Wednesday at about 50-50. That makes the meeting’s outcome a bit of a cliffhanger.

QUIZ: How well do you understand the Fed stimulus?

Here are five things to watch for as the Federal Open Market Committee releases its policy statement at 11 a.m. PST and then Bernanke holds court with the media one last time, starting at 11:30 a.m., before his term as chairman ends.

1. Is it taper time?

The key question is whether Fed policymakers stick with the pace of bond purchases, begun in September 2012, or decide the economy is strong enough to start reducing them with a goal of ending the program several months later.

The surprisingly strong November jobs report indicates that the economy has been adding an average of 204,000 net new jobs over the past four months. That’s the sustained level of job creation Fed officials have said they wanted to see before tapering the purchases, which were designed to push down long-term interest rates.

The unemployment rate also dropped to 7% last month, the level Fed policymakers have said they were aiming for when the stimulus program is to end.

So by that measure, the bond-buying already has done its job in substantially reducing the unemployment rate, which was 8.1% when the program began.

“The Fed has a checklist, and they pretty much fulfilled it,” said Diane Swonk, chief economist at Mesirow Financial.

But if Fed officials are checking their list twice, they’ll see that inflation has been running below the level they’d like.

The Fed’s preferred measure, based on personal consumption expenditures, showed prices up just 0.7% in the year ended Oct. 31, well under the 2% annual target.

“That’s the one fly in the ointment,” Swonk said.

Low inflation means the stimulus program is not causing prices to skyrocket, as some economists feared. It also could be a precursor to dangerous deflation: falling prices that could cause incomes to drop and job growth to stagnate.

If Fed officials decide not to taper this month, low inflation could be the reason they cite.

2. If they do taper, by how much?

Just because the Fed decides to reduce its purchases doesn’t mean it has to pull back dramatically.

Central bank policymakers could decide on a modest reduction of $5 billion to $15 billion a month -- enough to show they are more confident in the economy but not so much that it would send long-term interest rates sharply higher.

“Whatever they do, I think they will be aiming not to upset markets,” said John Makin, a resident scholar at the American Enterprise Institute. “So it will be a well-tempered taper if they do it.”

Makin said he thinks it’s a close call as to whether the Fed will taper on Wednesday (he’s leaning toward a January move). But when the Fed acts, he said, he believes it will trim the purchases by no more than $10 billion a month at first.

The size of the taper would be a gauge of how confident the Fed is in the strength of the economy.

3. Interesting interest rate guidance

Bond-buying isn’t the only way the Fed has been trying to stimulate the economy.

Since late 2008, the Fed has kept its key short-term interest rate at near zero. The low rate encourages banks to lend.

Fed officials have been clear that the rate is not going up any time soon; specifically, they’ve said it will stay near zero until the unemployment rate falls to 6.5% or lower.

But with unemployment now at 7%, that day might not be far off. So one way to temper the effects of a taper would be for the Fed to signal that it would keep its key interest rate at the record-low level for even longer.

Some analysts expect the Fed officials to say it will not raise the interest rate until unemployment falls to 6%.

The idea, Swonk said, is for the Fed to make sure financial markets know that the stimulus efforts will continue even if the bond purchases are winding down.
4. What’s the forecast?

How long Fed policymakers think we’ll have to wait before the unemployment rate drops to 6.5% or 6.% will be answered when they release their quarterly economic projections Wednesday.

Many economists have become more optimistic about economic growth in 2014 as recent data have indicated that the recovery has been strengthening.

When Fed officials released their last forecasts, in September, they downgraded them from earlier in the year.

If Fed policymakers upgrade their projections Wednesday, that would be another signal of confidence in the economy.

5. Parting words from Bernanke

Wednesday is the last scheduled news conference for Bernanke as Fed chairman. His second four-year term ends on Jan. 31. Fed Vice Chair Janet L. Yellen is expected to be confirmed by the Senate as his replacement, as soon as this week.

Bernanke began holding regular scheduled news conferences in 2011, the first for a Fed chairman, as part of his efforts to make the central bank’s workings more open.

But Bernanke is not particularly open about his own emotions.

He’ll eagerly answer question about economics and Fed policy, but is reticent to talk about himself or reflect on his tenure during arguably the most tumultuous period in the central bank’s history.

Expect Bernanke to be asked about his feelings as his tenure ends and what he thinks his legacy might be. Don’t necessarily expect any deeply detailed or profound answers from a man who likes to keep those thoughts to himself.

But the Fed often produces surprises, and Bernanke might decide he wants to open up as he prepares to head out the door.

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