(Bloomberg View) — When Federal Reserve officials started a rate-hiking cycle last month, they hoped their widely telegraphed policy action would neither derail the recovery nor overly destabilize financial markets.
As hard as it was for the officials to gauge exactly the extent of the financial markets’ dependence on Fed support, they couldn’t have also anticipated that a series of uncharacteristic policy mistakes by China, along with another steep drop in oil prices, would throw off market sentiment.
This week, the Federal Open Market Committee, the Fed’s top policy-making venue, will meet as markets are undergoing a transition in both volatility and liquidity, which has accentuated the “unusual uncertainty” besetting the global economy.
Here are four indications of what Fed officials are likely to do and not do:
1. The Fed will not repeat its 25 basis-point interest rate hike of December.
Further tightening would risk fueling the volatility in markets. Moreover, liquidity conditions already have tightened as a result of recent market developments. As a result, the Fed will wish to avoid aggravating the risk of market instability contaminating economic fundamentals.
2. The Fed will not reverse course and cut interest rates.
There is no compelling evidence of a material weakening in the U.S. economic outlook, at least for now. Fed officials would worry, correctly, that such a move could be interpreted as an act of policy panic, which would further spook companies that already are hesitant to deploy their large cash balances into higher capital spending,
3. The Fed’s narrative will acknowledge the recent market volatility, coupled with the risk of further economic weakening abroad.