The Fed is expected to hold interest rates steady Wednesday, but leave the door open to future rate hikes in a carefully crafted statement.
But the Fed statement is also expected to reveal that at least two board members disagree with the central bank's inaction. Those dissents illustrate the divide on the Fed board that has shown up in conflicting comments from Fed officials and could add to volatility in the markets.
"The problem is you've got disagreement. The gap has widened," said Diane Swonk, CEO of DS Economics. "You've got dissents. When you have dissents, you have volatility."
Cleveland Fed President Loretta Mester is expected to join Kansas City Fed President Esther George in dissenting Wednesday.
The market takes its cues mostly from Fed Chair Janet Yellen, who is viewed as one of the most dovish voices on the FOMC and has promoted a slow path to hiking. But central bank officials have been sending mixed messages about rate increases, and some officials see danger in keeping rates near zero for too long.
Even Boston Fed President Eric Rosengren, viewed as a dove, said recently that the markets have it wrong and are not pricing in enough rate hikes.
Fed watchers say the disagreements on the board make drafting the post-meeting statement difficult. The statement is expected to be released at 2 p.m. EDT, and the market is watching for any change in description about the balance of risks for insight on the policy path.
Michael Arone, chief investment strategist at State Street Global Advisors, said the Fed is unlikely to suggest that risks are balanced. "If they tell you it's nearly balancing, that'll be a signal that June is on the table," said Arone. He does not expect the central bank to explicitly point to June as the next time it could hike rates, but there has been concern about that in the bond market.
The Fed is expected to be dovish in its statement, but the bond market clearly has been fearing it will be a bit more hawkish, and yields have been rising. Treasury yields reversed course Wednesday and were lower ahead of the statement.
"I don't think they can put the balance of risk back in, because they can't agree what the balance of risks are," said Swonk. "It just means continued uncertainty, continued uncertainty for the market."
The nuances will be important, particularly since there is no news conference where Yellen can provide further clarification.
"They're walking this very fine line which means they can't provide the certainty that markets want, but it's really not helpful either. It's a very dysfunctional Fed confusing the market," Swonk said.
Market expectations are for the next rate hike to come early next year, but the Fed has said it anticipates two rate increases before then, so there is automatically tension around any statement it would make.
"I don't think they're going to tip their hand on the policy section of it. I think the hawkishness might come in their description of the economy, because credit spreads have come back and are no longer a worry. The stock market is no longer down 10 percent on the year. Even the G-20 was less concerned about the economic outlook for the world," said Chris Rupkey, chief financial economist at MUFG Union Bank.
Rupkey said while he does not expect the Fed to point to June for the next hike, he said the divided board makes it more difficult to predict the outcome.
"You can't count them out. It's a very split committee. There's some on there that want to go faster," he said. "There's no need for them to jump up and telegraph to the market that June's the one, but you never know. That's why I think it's appropriate for yields to move up a little."
The Fed could also send an unintentionally hawkish message to the markets. "It could be as much as them stepping over the weakness in the first quarter and making it out to be temporary," Rupkey said.
U.S. economic data have been spotty, with more than a few misses recently. Durable goods were weaker than expected Tuesday, and first-quarter GDP, scheduled for Thursday, is predicted to be just barely positive.
Arone said he will be watching to see if Yellen's perspective is dominant in the statement. "My view is what Yellen did with her Economic Club of New York speech (March 29), she was saying: 'I'm the chairperson. This is my view. We're going to go slow and gradual.' At the time, other Fed officials were talking about how April was still on the table," Arone said. "I think what markets are going to be looking to see is if that remains the message or if we're back in this kind of limbo."
Yellen's speech came after a few Fed officials said it was time for the central bank to consider rate hikes. The 25-basis-point hike in December was the first in nine years and the first move away from the zero interest rate policy.
Swonk said the Fed is in a tough spot, as its tightening of policy moves against the policies of other central banks that are easing.
"Divergent monetary policy matters because you can derail stuff inadvertently, and that's what the Fed doesn't want to do either," she said. "What happens abroad comes back on our shores. The Fed has to walk such a careful line of saying they're doing monetary policy for the U.S. but they can't ignore international conditions."
It will also be important to see if the Fed gives any nod to stability in international markets now that China has calmed some of the fears around its economy.
Arone said the Fed will want to leave options open. "I don't think this Fed, and Yellen in particular, likes to paint themselves into a corner," said Arone. "The statement will acknowledge that growth in the economy is modest. They haven't seen the flow through to inflation and they'll remain data dependent going forward."