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Just like last year, the Fed could be hiking rates into a weak economy

This week's FOMC meeting will conclude Wednesday probably with the Fed only hinting but not promising an increase.

Federal Reserve Chair Janet Yellen
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Federal Reserve Chair Janet Yellen

If the Federal Reserve hikes interest rates in December, it will do so under similar, difficult conditions it encountered with the move it took at the same time a year ago.

While the U.S. economy has shown a bit more life recently, full-year growth is unlikely to eclipse 2 percent, and fourth-quarter gains probably won't mirror the mild burst the third quarter saw.

That will leave the central bank in much the same predicament it was in last year, when it approved an increase in a fourth quarter that saw GDP grow just 0.9 percent.

After clearly signaling in October that a December rate hike was coming, the Fed had virtually no choice but to move. Now, the market again is pricing in tightening (giving it a 74 percent probability), so the Fed probably will go next month. (A move this week is all but off the table for multiple reasons, not the least of which is next Tuesday's presidential election.)

However, there likely will be two key differences in how Federal Open Market Committee members approach the move.

First, this week's meeting will conclude Wednesday probably with the Fed only hinting at, but not promising, an increase. Second, when the Fed hiked last year for the first time in nearly a decade, the decision came with officials indicating that four more moves would be on the way in 2016. The net result was two months' worth of market volatility in which the S&P 500 flirted with bear market territory. The Fed has yet to hike even once this year.

This time, should the FOMC approve a rate hike, it will do so with firm language that the future pace will be slow.

"We do expect the Fed to make tweaks to the language to emphasize that a hike is likely coming in the December meeting. In our view, the Fed is unlikely to take a page out of last year's playbook and explicitly mention the possibility of a hike in December," economist Michelle Meyer and colleagues at Bank of America Merrill Lynch said in a client note. "We think the Fed's objective is to signal that a hike is highly probable in December, but that the path thereafter will be extraordinarily shallow."

Fed officials already have done some of the heavy lifting regarding expectations, with September's projections reducing the outlook for hikes to two in 2017 and three in 2018, a move Meyer called "a big capitulation," particularly considering that the Summary of Economic Projections last December projected four hikes a year through 2017.

Traders now expect the Fed's target rate, currently at 0.41 percent, to end 2018 at just 0.94 percent, the rough equivalent of two quarter-point hikes.

The Fed has scaled back primarily because economic growth has been soft, particularly when it comes to inflation. Recent economic data will do little to change that.

Yes, third-quarter GDP came in at 2.9 percent, but that was due largely to a jump in exports and other factors that will be hard to sustain. As for inflation, it remains well below the Fed's 2 percent target, with the underlying trend stuck at 1.7 percent.

In fact, the Fed's favored personal consumption expenditures gauge has been below target for 53 straight months, the third-longest streak ever, according to David Rosenberg, chief economist and strategist at Gluskin Sheff.

Overall, the fourth quarter started out on a rough note.

The Goldman Sachs Analyst Index, which measures growth across a spectrum of indicators, fell to a contraction-like 48 in October from 56.5 in September. (As a diffusion index, 50 is the dividing line for growth.) The index saw steep declines in sales and shipments as well as new orders while inventories, which also pushed third-quarter growth, were flat.

Most analysts found growth "weak but stable," Goldman said in a report.

Against that backdrop, the Fed will have to be careful both in what it does and how it signals.