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Softening data set to stay Yellen's hand

If Fed officials are trying not to rock markets, their post-meeting statement Wednesday may be super dull.

The Fed winds down its two-day meeting with a 2 p.m. ET statement, and the central bank is not expected to increase interest rates or take other action. The Fed surprised Wall Street when it held off on a rate hike in September, but since then the economic data has softened and the global headwinds the Fed pointed to in its September statement remain.

The language in this new statement has the potential to stir up markets, with many speculating it will sound more dovish than intended simply because the Fed will have to recognize the sluggish economic data. The Fed should also try to keep the door open for a December rate hike.

"I think it's in the Fed's best interest to be as boring as possible and not lean in any one direction," said Peter Boockvar, market strategist with Lindsey Group. "Imagine if they set us up for a rate hike in December, and then we get weak payroll numbers and they pull back again?"


Janet Yellen
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Janet Yellen

Fed Chair Janet Yellen and several other officials have maintained that the Fed would like to hike rates this year for the first time in nine years, depending on the economic data. But others, like Fed Governors Daniel Tarullo and Lael Brainard have been outspoken, saying the Fed should not raise rates this year because of the economy.

"The success for the Fed would be if they're able to craft a statement that is balanced enough not to move the market in either direction because they would still have communicated there's a possibility. They don't want to close the door on December," said Diane Swonk, chief economist at Mesirow Financial.

"I think it's wrong when people say it's black or white, hawks versus doves. I wouldn't paint Janet Yellen as a hawk. Her challenge is to lay out for the market that the Fed agrees more than it disagrees."

The disagreement among members has confused markets and made the Fed's job challenging because any downgrading of the economy in its post-meeting statement could increase the betting by market players that the Fed will wait until next year to hike. Odds in the futures market already point to just over a 30 percent chance of a hike in December.

"This is a case where you could get a dovish outcome. At least the market would interpret it as a dovish outcome," said Michael Gapen, chief U.S. economist at Barclays.

He said Fed officials, in the more than a dozen speeches scheduled in coming weeks, could come out and nudge the view either way. Fed Chair Janet Yellen speaks Nov. 4 on regulatory matters, but more importantly gives testimony on the economy Dec. 3 before the Joint Economic Committee of Congress.

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The public disagreement among Fed officials could also slow down action by the Fed, said Gapen. He expects a first rate hike in March.

"Our basic argument is we don't think they will resolve their differences this week so when that typically happens they don't make major changes to the statements. They would make minimal adjustments so they change the paragraph on incoming data," he said. "Divided committees rarely arrive at a consensus meeting outcome and then you could have a couple of meetings where they don't do much of anything."

Gapen said the Fed could also see an increase in dissents, on either side depending on its action in December and into next year.

The flow of data after the September meeting has been weakish, including the October nonfarm payrolls that showed job creation at just 142,000. Just on Tuesday, new orders for durable goods fell a seasonally adjusted 1.2 percent in September, from the month before, and consumer confidence fell to 97.6 in October from the expected 103.

"Absent a rip-roaring acceleration in the data in the next couple of months, it's going to be difficult for the Fed to move," said Joseph LaVorgna, chief U.S. economist at Deutsche Bank. "If they say there are downside risks, that shows they're not going in December."

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In the time since the Fed pointed to international developments as a driver for keeping rates on hold, weakness in Chinese data has continued and it could refer to that.

He said the Fed saw that the growth rate for third quarter U.S. GDP would be closer to 1 percent when reported Thursday. "They have to acknowledge weaker growth," he said.

Third-quarter gross domestic product (GDP) is expected to show growth of 1.4 percent, compared to 3.9 percent in the second quarter, according to a CNBC/Moody's Anaystics Survey.

Gapen said the number would illustrate both sides of the economic debate about whether international influences were hurting growth and whether the U.S. economy was stronger domestically.

The main drag will come from trade and inventories, symptomatic of softness abroad. "But if you look at GDP, less trade and less inventories, which is an indicator of more true domestic demand, that should run around 3.6 percent. So those who want evidence that the economy is more solid will get evidence of that too," he said.

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One problem for the Fed has been inflation, which has remained stubbornly low and with weak commodities prices, does not show signs of picking up. One thing that could help would be wage growth.

"I'm more hopeful that they'll signal more of a road map in their statement. They can't signal whether they'll go or not but a good compromise would be to put in a statement on wages as well as inflation," said Mesirow's Swonk. The Fed will have third quarter GDP, the employment cost index and two monthly employment reports between now and the December meeting.

"They could signal with compromise what they mean in terms of what could actually get them to go," said Swonk.

She said Yellen was good at building consensus but didn't have much time during the September meeting.

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"We're now feeling the vulnerability of transparency and uncertainty. My sense is that a lot of people see that within the Fed…It's been fairly foggy, and I think they have to compromise to show us something that's less foggy. I don't think they want to have the first rate hike that has dissents from members of the board of governors."