U.S. Federal Reserve Board chair Janet Yellen and her policy-setting colleagues find themselves in a familiar quandary heading into their two-day policy meeting Tuesday. Should they raise interest rates in response to improving labour, consumer spending, inflation and other data? Or should they hold their fire as they monitor the fallout from the global slowdown and further intervention by their counterparts in Europe, China and Japan?
Ms. Yellen is in the unusual position of having enough evidence to make a reasonable case for either option, as she presides over a group that seems more divided than usual on which path to pursue.
The markets are betting the Fed will stand pat for the second time since raising its key rate by a slim quarter of a percentage point in mid-December. That was supposed to be the start of a U.S. tightening cycle – the first in nearly a decade – that would see perhaps four modest increases in 2016. But that was before mixed U.S. signals, worsening global conditions and a bout of severe market turbulence clouded the picture.
"They're not likely to do anything," said Avery Shenfeld, chief economist with Canadian Imperial Bank of Commerce. "They're poised to tighten a bit [this year]. But it's a divided Fed, even on the board of governors, where you tend to have more of a common view, and that was very much revealed in recent speeches."
CIBC cut its own forecast to two quarter-point hikes this year from an earlier prediction of three.
Most Fed watchers agree, expecting no more than one or two increases, along with clear language signalling that the central bank remains in a tightening frame of mind. Although a rate hike this week is unlikely, "We expect officials will continue to project much more tightening ahead than is being priced into fixed-income markets," Jim O'Sullivan, chief U.S. economist with High Frequency Economics, said in a note to clients.
Some analysts are convinced policy makers will be reluctant to widen the divergence between the Fed and its counterparts in Europe, China and Japan, which are rummaging through their depleted tool kits for new ways to prop up teetering economies.
Further U.S. interest-rate rises risk supercharging an already overpriced U.S. dollar, driving up financing costs, hitting American exports and manufacturing employment, and further destabilizing markets.
The European Central Bank cut interest rates and boosted its bond-buying program by one-third on Thursday. Japan's central bank introduced negative rates last month and insists it is prepared to do more easing to cope with a moribund economy.
"We have a lot of very positive developments in our domestic economy," Fed governor Lael Brainard told CNBC last week, just ahead of the Fed's self-imposed blackout in advance of policy meetings. Among other promising signs, the bank's leading policy dove cited the return of large numbers of people to the labour force, stronger consumer spending and decent income growth.
But on the negative side of the ledger, Ms. Brainard counted "very strong cross currents from abroad" that could spill over into the U.S. economy. "So there is some downside to the domestic outlook."
A stronger greenback and tighter financial conditions have already produced what amounts to three quarter-point rate increases, she told a financial conference in New York last month. She advises patience by fellow policy makers eager to return a semblance of normalcy to monetary policy.
"I'm not shocked to see that she's staying very, very cautious," said Jennifer Lee, a senior economist with Bank of Montreal. Fed policy makers seem less hawkish than they sounded just months ago, and Ms. Brainard was no hawk to begin with.
"She went on board with one hike [in December], but hasn't been impressed enough with the news since then to think that they should continue," Mr. Shenfeld said.
But at this point, the greenback may not have much more room to climb. And the Fed has shown a willingness to surprise markets in the past.
"The Fed should not be overly sensitive to chasing markets, but at a minimum should have comfort that market fears earlier this year have calmed down," Bank of Nova Scotia economist Derek Holt said in a report laying out a case for why the central bank could choose to raise rates sooner rather than later.
A "scenario marked by a strong majority in favour of a [rate] hike is not the least bit implausible."