Market stability X factor in Fed step

WASHINGTON -- At their most anticipated meeting in years, Federal Reserve policymakers will sit at a 27-foot table of Honduran mahogany and decide whether it's time to raise a key interest rate for the first time in nearly a decade.

Looming over them at one end of the central bank's ornate, two-story boardroom will be a mural of the United States. The map is a reminder that Fed Chairman Janet Yellen and her colleagues are supposed to put the nation's economic interests above all others.

The central bank has a dual charge from Congress: maximize U.S. employment and keep prices in the U.S. stable. But since the recession, Fed leaders have acknowledged that there's an unwritten third mandate: financial stability.

And that third mandate could be the X factor in a too-close-to-predict decision, to be announced today, about whether the U.S. economy is ready to start being weaned from the unprecedented stimulus provided by the near-zero short-term interest rate in place since late 2008.

Even though most data show the economy growing solidly, the recent turmoil in global financial markets could make already-cautious Fed officials skittish about adding to the volatility by raising their benchmark federal funds rate -- even by no more than a mere quarter of a percentage point.

"Obviously the labor market and inflation is going to be first and foremost the most important thing they watch," said Lindsey Piegza, chief economist at brokerage firm Stifel Nicolaus & Co.

"But I think if they were looking for an excuse [not to raise the rate], the increased uncertainty surrounding the global marketplace is enough to provide them with justification to wait further," she said.

There's no consensus about what the Fed will do, which in itself is causing financial market jitters. About half of economists surveyed recently by Bloomberg predicted a rate increase this week.

Financial markets, however, are expecting the Fed to hold off, with a key indicator showing only about a 30 percent chance of a rate increase. That would point to a stock market drop if the Fed raises the rate, unless policymakers were to soften the blow by promising that another increase would be a ways off.

On Tuesday, the Dow Jones industrial average jumped 228.89 points, or 1.4 percent, to 16,599.85. The stock market continued its recovery Wednesday, with the Dow rising 140 points, or 0.84 percent, to 16,739.95.

The rally was triggered by expectations that Fed policymakers will hold the rate steady today, said John Lonski, chief economist at Moody's Capital Markets Research Group.

"It would be a surprise if the Fed hiked rates at this point in time," he said. If Fed policymakers did, "they would have to go to great lengths in their policy statement to hold financial markets' hands so they don't panic."

Other experts argued that a rate increase would calm financial markets because it would remove uncertainty about when the Fed would act.

Just a month ago, the Fed seemed on track to raise the rate by 0.25 percentage point this month, the first small step in a slow tightening of monetary conditions that would validate the strength of the U.S. recovery.

Yellen had said through the spring and early summer that she expected a rate increase this year despite complaints from liberals that more economic progress was needed.

Although job creation slowed in August, labor market growth has been solid this year. The unemployment rate dropped to 5.1 percent last month, the lowest in more than seven years and near the level the Fed considers to be full employment. Wage gains have shown signs of picking up.

And although inflation continued to run below the central bank's annual 2 percent target, Fed policymakers said a key reason was the temporary effect of sharply lower oil prices.

The economy "can cope with higher rates, and needs them given the tightness of the labor market," said Ian Shepherdson, chief economist at Pantheon Macroeconomics.

But financial markets around the world started convulsing late last month after China devalued its currency. The Dow Jones industrial average dropped as much as 16 percent below its record high in May as investors feared a slowing Chinese economy would drag down global growth. The market has rebounded somewhat this month, with the Dow now down nearly 10 percent from the May high.

For Fed policymakers, the market turmoil adds to the complex calculus of when to raise the interest rate.

"Absent what happened in financial markets and the news about the weakness in the Chinese economy over the past couple weeks, they would be tightening at this meeting," said Stephen Oliner, a senior research fellow at the UCLA Ziman Center for Real Estate and a former Fed official.

Now, he predicts, they'll wait at least a month to get a better handle on the effects.

"There's a lot of uncertainty about what the impacts on the U.S. economy are going to be, and they have almost no data to rely on that postdates the developments in China," Oliner said.

The health of the global economy isn't one of the Fed's primary concerns, so technically it shouldn't be factored into its decision making. But, in effect, the Fed has become the monetary authority of the world.

The central bank's influence in recent years has been enormous. The mere hint by then-Chairman Ben Bernanke in 2013 that the Fed might "taper" its monetary expansion triggered market convulsions around the globe.

Business on 09/17/2015

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