The Federal Reserve is likely to hold rates unchanged on Wednesday but keep the markets primed for further monetary tightening as it surveys steady growth and a tightening labour market.
Recent statements from Fed chair Janet Yellen have suggested that she does not want to rush into a third rate increase, but that she also has no intention of letting the US economy overheat.
This points to a move at some point in the first half of the year, depending in part on how soon US policymakers obtain greater clarity about the Republicans’ tax and spending plans.
What will the Fed’s message be?
The central bank seems likely to seek to keep its options open as it awaits further evidence about the size and composition of any loosening of budgetary policy.
The Fed is not producing new economic forecasts or a fresh interest rate outlook at this meeting, so this is not a gathering at which it can send detailed signals.
In its post-meeting statement it may note a slowing in growth in the final quarter of last year but this is unlikely to be of concern to rate-setters: the overall picture remains one of a steady expansion with firm consumer spending, strong hiring and inflation that continues to edge closer to the Fed’s target.
“We do not think the committee will want to give any strong signals about the near-term course of policy at this juncture,” said Kevin Logan, chief US economist at HSBC.
“The latest economic data have not generated any particular surprises that would suggest the FOMC needs to speed up the pace of tightening to achieve its dual goals of maximum employment and 2 per cent inflation.”
What is the impact of possible fiscal changes?
The Republicans are considering sweeping tax reforms that would lower corporate and personal tax rates, while President Donald Trump has been touting the need for infrastructure spending.
Tax plans advanced by Mr Trump during the election would add about $7.2tn to the national debt over the next decade, according to the Tax Policy Center, while House Republicans’ plans would lift federal debt by at least $3tn.
If in the coming months the Republicans do look set to embark on a loosening of fiscal policy, the Fed is likely to respond with higher interest rates as it seeks to ward off any risk of accelerating inflation.
The minutes to the latest meeting in December suggested that a number of policymakers are already building in assumptions of some sort of fiscal change, as are staff at the Federal Reserve Board.
When will the next upward move come?
Ms Yellen said in back-to-back speeches in January that a “nasty surprise” could be waiting around the corner if the Fed waits too long before lifting rates, while insisting that the central bank was not behind the curve in tightening policy.
The words suggested that the Fed does not see 2017 in the same light as 2015 and 2016, when it moved rates up at only a once-per-year pace. Ms Yellen suggested that a “few” rate increases per year could be in the cards between now and 2019.
The fact that rate-setters have started talking about how to reduce the size of the Fed’s balance sheet, another means of tightening policy, also sends a hawkish signal about 2017.
The statement on Wednesday is unlikely to refer to this, but minutes of the meeting released later in February may well record a discussion on the topic.
Markets expect the central bank to hold fire before lifting rates again in June, but if the uncertainty surrounding fiscal policy is dispelled soon and economic data continue to strengthen, it is perfectly possible that the US central bank could move before then. The next two US rate decisions will come on March 15 and May 3.
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