Fed to enter tricky waters of U.S. rate forecasts

The US Federal Reserve enters uncharted waters at its policy meeting this week as it reveals individual policymakers' views on the future path of interest rates.

Fed-watchers generally expect the central bank will leave monetary policy essentially unchanged after the economy has recently shown some signs of an improving recovery from a deep recession.

The Federal Open Market Committee policymakers have pledged to keep the key federal funds rate between zero and 0.25 percent through mid-2013 to support growth.

The overnight interbank lending rate has been held at that historic low since December 2008.

There is speculation, however, that the FOMC may decide the economy needs extra juice to keep growth humming, particularly as Europe veers back toward recession amid the eurozone sovereign debt crisis.

But most analysts discounted the notion of the FOMC opting for further stimulus measures at the two-day meeting that opens Tuesday.

Still, the FOMC meeting "should be eventful," said Ryan Sweet and Aaron Smith at Moody's Analytics.

"We expect significant changes to the (FOMC) statement and to the Federal Reserve's quarterly economic projections."

All eyes will be on Ben Bernanke's post-FOMC news conference. The Fed chairman will present the central bank's current economic projections and discuss the panel's monetary policy decision.

But attention also will be fixed on the Fed's new communications policy which includes individual committee members' rate projections and the timing of the first rate hike in the outlook reports.

"The immediate focus on Wednesday will be on two things: the timing of the first rate hike and any hints of QE3," Societe Generale analysts said.

The Fed has undertaken two rounds of quantitative easing (QE), or asset purchases, to stimulate the economy.

The Fed's Beige Book report prepared for the meeting said the economy was slightly improving and growing at a "modest to moderate pace," though the rate was still too weak to spur inflation.

The Fed, with a dual mandate of maximum employment and stable prices, has highlighted a high unemployment rate -- at 8.5 percent in December -- and the depressed housing market as major obstacles to a sustainable recovery.

Some analysts predicted the Fed would push the first rate hike back to 2014, noting that such an assumption already had been priced into the markets.

The change in the Fed communications strategy to include rate projections has been hailed as a giant step toward enhancing transparency, even a move toward setting a rate target.

"The immediate benefit is that it will allow the FOMC to replace the implicit commitment of keeping rates near zero until mid-2013 with more flexible guidance," Barclays Capital analysts said.

But others warned that the new strategy could backfire, only upsetting markets, or prove a dud.

"With all the new information being released, the chance for some communication miscue is high," said Bank of America Merrill Lynch analysts.

"In time, enhancements to Fed transparency should reduce market volatility, but the transition period could be a bit rocky."

Robert Brusca, at FAO Economic, pointed out that some of the forecasts may have an "uneven shelf life."

"The Fed will also unveil forecasts from time to time that will be made moot by events almost immediately and leave us back at square one," wondering what the Fed would do now that the event had "turned its outlook to mush," he said.

"The Fed game has not really changed as the Fed agrees to show us its undergarments."

[Image via Shutterstock.com.]