Federal Reserve

Looming Fed rate decision a test of Yellen's jobs vision

How the Fed rate hike affects the stock market

Fed Chair Janet Yellen has made clear she would rather delay an interest rate hike for too long than move sooner and risk jeopardizing a tepid economic recovery, a conviction that will face its sharpest test yet on Thursday.

Having weighed the economy's steady march toward full employment against the backdrop of weak inflation and wage growth and turbulence overseas, the U.S. central bank will issue its latest rate decision at the end of a two-day policy meeting.

A rate hike would be the first in the United States in nearly a decade. Fed watchers, however, see the outcome as a toss-up, with Yellen's consistently stated desire to see workers reap more benefits from the recovery, coupled with weak price rises and a variety of global risks, looming large.

Drew Angerer | Bloomberg | Getty Images

"It is a game-time decision. The key is what Yellen thinks and my guess is that she will want to wait," said Mark Zandi, chief economist for Moody's Analytics. "If you put yourself in her shoes, you don't want to err by going too soon."

That's a mistake the European Central Bank made twice in 2011.

In addition to the release of the policy statement at 2 p.m. EDT (1800 GMT), Fed policymakers also will issue a fresh set of economic projections that will provide insight into the expected pace of subsequent rate hikes and other key economic matters.

Yellen will hold a press conference shortly after.

Investors, economists and analysts are broadly divided over whether the Fed will decide to put more stock in continued U.S. growth, pushing ahead with a rate hike, or defer to concerns about the health of the global economy in delaying the rates "liftoff" until October or December.

A general view of the Federal Reserve Building in Washington
Poll: When will the Fed raise interest rates?

Financial markets have stabilized since an August bout of volatility and concerns about an economic slowdown in China threw the U.S. central bank off course from what seemed to be an inexorable move toward a rate hike this week.

Markets unconvinced

But for a Fed that likes to wear a "data-dependent" mantle, recent U.S. economic numbers have provided little comfort in embarking on the final turn away from the policies it embraced in the wake of the 2007-2009 financial crisis.

The unemployment rate plunged to 5.1 percent in August, a figure arguably at or near the Fed's goal of full employment, and historically out of line with a federal funds rate at near zero. Consumer spending continues to hold up and Fed officials expect the economy to continue to grow at a steady pace.

But a key measure of inflation fell last month, leaving the Fed far from its other policy goal—a 2 percent inflation target—and bolstering the case that there should be no rush to raise rates until prices and wages begin to increase.

Central bank policymakers for nearly a year now have said the impact of a stronger U.S. dollar, falling global oil prices, and weak world demand would fade, allowing inflation to rise towards their target.

They must now decide whether they have enough confidence in the economy's underlying health, the state of financial markets and the likely fallout from a rate hike to move forward. Either way, they could trigger dissents from a group of policymakers adamant about hiking rates now and another group equally keen to wait.

Traders work on the floor of the New York Stock Exchange.
Unconventional ways to play the Fed decision

"A good argument for raising now is that everybody knows that a rate increase is inevitable and speculation about the timing is creating a lot of volatility. One way to reduce that is to end the guessing game," said Ann Owen, an economics professor at Hamilton College in Clinton, New York, and a former Fed economist.

Recent weeks have made the Fed's job harder. Markets that had priced in a high probability of a September rate hike have now pushed that expectation off to December or beyond.

Eighty economists in a recent Reuters poll were divided over whether the Fed would hike rates on Thursday, with 45 expecting it to remain on hold.

Traders on Wednesday saw a 29 percent chance the Fed would end its near-zero interest rate policy at this week's meeting, based on overnight indexed swaps rates; chances of a December hike stood at 83 percent.