(Bloomberg) — Janet Yellen's big challenge next week is clear communication about a clouded outlook.
The Federal Reserve was expected to leave interest rates unchanged at their Jan. 26-27 meeting even before the recent rout in global stocks. But just six weeks after policy makers forecast four rate hikes this year amid solid growth, the world looks a more precarious place.
Equity prices from Japan to Brazil have tumbled into a bear market, China's economy slowed and oil prices are lower, prompting European Central Bank President Mario Draghi to warn Thursday that downside risks have increased.
Yellen has been publicly silent since assuring investors on Dec. 16 that tightening would be gradual, after the Federal Open Market Committee hiked its benchmark policy rate for the first time since 2006. Though there is no press conference scheduled to follow next week's meeting, she's expected to take a more nuanced approach than her European counterpart in the policy statement the Fed will issue after Wednesday's meeting.
"The December statement is relatively fresh, and I don't think there's any urgency to change the underlying tone," said Ward McCarthy, chief financial economist at Jefferies LLC in New York. The committee will try to walk "a fine line between avoiding contributing to hysteria but remaining relevant and credible."
'No limits'
Draghi said officials will review their programs at the next policy session in March and there are "no limits" to how far they're willing to deploy measures within the ECB's mandate.
The FOMC must acknowledge the threats to growth and their 2 percent inflation target even while U.S. labor markets are strong. Voicing too much concern, however, could rattle markets even more and dim expectations of further rate hikes, complicating communications down the road.
The FOMC will have to say "that financial markets and oil markets have come down without signaling they are done with their rate cycle," said Robert Martin, U.S. economist at Barclays Capital Inc.
It's a difficult task. The committee must persuade investors that volatility in stock markets doesn't automatically translate into weaker U.S. growth, and they have six more weeks until the March meeting to gauge the impact on the world's largest economy of a dimming global outlook.
Fed thinking
So while the committee will surely review their outlook for growth and pushing inflation up toward target, one goal will be to get financial markets back in line with their thinking.
Investors see the probability of a second rate hike this year as less than 50 percent, based on pricing in fed funds futures, and view the odds of a hike in March at 20 percent, down from 45 percent this time last month.
"Anything they do that may sound a little more dovish does have a significant chance of validating the market pricing in fewer rate hikes," said Michael Hanson, a U.S. senior economist at Bank of America Corp. in New York. "They want to be careful not to feed the pessimism."
