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As Fed meets, markets fixate on 2 words

Paul Davidson
USA TODAY
Federal Reserve Chair Janet Yellen will lead a meeting of policymakers that begins Tuesday.

A two-word change in the Federal Reserve's post-meeting statement on Wednesday could drive speculation that the Fed will raise interest rates sooner in 2015 than investors expect.

Some economists predict policymakers will remove from its statement a long-standing assurance that a key short-term rate will likely stay near zero for a "considerable time" after a bond-buying program ends.

And that could roil financial markets.

At a two-day meeting starting Tuesday, Fed policymakers are expected to continue to wind down the bond purchases, which they have used for two years to hold down long-term interest rates. The purchases are likely to end next month and, based on what Fed policymakers have indicated, they expect the first rate hike to come in mid-2015.

But with the labor market strengthening recently, Fed officials recently have said rates could rise sooner than anticipated if the positive trend continues. Charles Plosser, head of the Philadelphia Fed, dissented from the Fed's July statement, saying the Fed's rate guidance "does not reflect the considerable economic progress that has been made" toward the Fed's economic goals.

The unemployment rate has fallen to 6.1% from 7.2% the past year. And the economy grew briskly in the second quarter.

Plosser is known for focusing more on keeping inflation from spiraling higher. But Boston Fed chief Eric Rosengren, who's known for trying to stimulate economic growth, said in a recent speech that the Fed "should be moving away from providing date-based forward guidance, and instead focus on" the recovery's progress.

With both ends of the Fed's policy spectrum in favor of removing the "considerable time" language, JPMorgan Chase economist Michael Feroli says such a move is likely this week. To ease concerns about rates rising too early, derailing the recovery, Feroli says the Fed could add that the tweak doesn't change policy.

Also, bond futures prices show that markets expect the Fed to raise interest rates more gradually than Fed policymakers' forecasts indicate. Some economists say the Fed likely wants to shift those expectations — a message it could send by signaling an earlier rate hike.

Others say ditching the phrase would spook markets, pushing up rates and crimping growth. "You're telling markets rates will go higher sooner," says Barclays Capital's Michael Gapen, a former top Fed official.

Chief Economist Jan Hatzius of Goldman Sachs says a change is not supported by recent economic data. Monthly job growth slowed in August, and inflation has moderated. Also, bond yields already have edged higher, potentially raising borrowing costs for businesses and damping growth.

Gapen predicts the Fed will keep "considerable time" but add that rates could rise sooner if the job market continues to advance more quickly than expected.

Specialist Glenn Carell, center, works at his post on the floor of the New York Stock Exchange.
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