The Federal Reserve meeting: Five things to watch for

WASHINGTON -- Is it taper time for the Federal Reserve?

That’s the key question as the financial and economic worlds await the end of the central bank’s policymaking meeting Wednesday and Fed Chairman Ben S. Bernanke’s quarterly news conference.

The central bank’s Federal Open Market Committee will release its policy statement at 2 p.m. EDT. Thirty minutes later, Bernanke will sit behind a custom-made desk to detail the committee’s actions and reporters’ answer questions.

QUIZ: How well do you understand the Fed stimulus?

There’s great attention on the Fed as Bernanke heads into the final months of his second term as chairman.

Washington has been buzzing with speculation about his successor. A strong liberal backlash to the top contender, former Treasury Secretary Lawrence H. Summers, led him to surprisingly withdraw from consideration on Sunday.

The move left the other leading candidate, Fed Vice Chair Janet L. Yellen, as President Obama’s likely choice to lead the central bank as it tries over the next couple of years to end its stimulus efforts without damaging the economic recovery.

Meanwhile, Wall Street and financial markets have been anxiously awaiting the Fed’s decision on reducing its year-long bond-buying stimulus program.

Interest rates shot up after Bernanke said in May the Fed could begin tapering the $85 billion in bond purchases within a few months. And all eyes were focused on the Fed’s September meeting as the probable date when such a move would be announced.

Here are five things to watch for from the Fed and Bernanke on Wednesday.

1. Will the Fed taper?

There’s broad expectation that the Fed will vote to start tapering its bond purchases Wednesday. Given that’s what the financial markets are anticipating, the Fed is likely to go forward to avoid rattling investors.

“You’ ve created the volatility, you’ve built the expectations,” said Gary Schlossberg, senior economist at Wells Capital Management, who predicted the tapering would begin Wednesday. “The market has begun to price in the possibility of an extended pullback.”

But Bernanke and other Fed officials have said they would move only if the economy continued to recover as they expected. And recent economic data suggest the economy might not be picking up in the second half as forecast.

In addition, fights in Washington over the federal budget and the debt limit pose a risk to economic growth and could give the Fed pause.

Still, the Fed has made clear that even if it does start reducing its bond purchases, it could increase them again. So moving forward, particularly with a slow taper, has little downside.

2. If the Fed does taper, how much will it pull back?

Because of the continued uncertainty about the economy, the Fed probably will start with a small reduction.

“I think they want to say, ‘We’re starting,’ but not start very fast,” said John Makin, a monetary policy expert at the American Enterprise Institute, a Washington think tank.

He said the Fed might do just $10 billion a month less in purchases.

A survey of 47 economists by CNBC released Tuesday found the average expectation was for a reduction of about $15 billion.

3. Will the Fed cut back on buying mortgage bonds?

If the Fed is concerned about the housing market recovery, which has slowed as mortgage rates have risen in recent months, it could decide not to reduce its purchases of mortgage bonds.

The Fed has been purchasing $45 billion in Treasury securities and $40 billion in mortgage-backed securities.

Fed officials could reduce only the Treasury purchases, keeping in place the same level of support for the mortgage market as the overall tapering begins. Or the Fed could reduce mortgage bond purchases only slightly.

For example, Schlossberg at Wells Capital is predicting a reduction of $10 billion in Treasury bond purchases and $5 billion in mortgage bond purchases.

4. Any change to the Fed’s guidance on short-term rates?

One way the Fed could mitigate concern about its bond-buying pullback is by changing what it says about its other major stimulus initiative -- keeping short-term interest rates close to zero.

Fed policymakers have said they will keep short-term rates at that level at least as long as the unemployment rate remains above 6.5% (it was 7.3% in August) and inflation remains in check.

The most recent Fed projections, which will be updated Wednesday, don’t have unemployment dropping below 6.5% until at least 2015.

The Fed could alter its guidance to indicate the rates will remain low even longer.

Joshua N. Feinman, chief U.S. economist at Deutsche Bank, suggested the Fed could reduce the unemployment threshold for raising interest rates and reemphasize that it is only a threshold, not a trigger.

Bernanke could use his news conference to amplify that so-called guidance as a way to assure markets, as he has done before, that tapering is not the Fed applying the brakes to stimulus but just easing its foot off the accelerator.

5. Will Bernanke talk about his future?

As attention has focused on who will succeed Bernanke when his term as chairman ends Jan. 31, one thing has been missing: Bernanke hasn’t actually confirmed he’s leaving.

Bernanke has been mum about his fate when asked at previous news conferences. Expect him to get pressed again Wednesday, particularly because of all the attention to his potential replacement.

Bernanke probably doesn’t want to wade into the issue, but he might decide it’s time to confirm that he intends to step down. The announcement shouldn’t move the financial markets.

But it would put to rest one theory -- that President Obama could renominate Bernanke for a third four-year term.

“It’s not outside the realm of possibility,” said Brian Gardner, senior vice president at investment bank Keefe, Bruyette & Woods.

Summers apparently was Obama’s top choice. If Obama doesn’t want to nominate Yellen and wants to try to avoid a backlash from her supporters, Bernanke could be the best option.

Gardner said a third Bernanke term as Fed chair was a long shot, but that the chances were better than they were before Summers withdrew.

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