The Federal Reserve most likely won't be delivering any rate hikes at its meeting this week, but it can deliver something many investors are looking for: hope.
As Wall Street seeks to hold on to a stunning 50 percent rally off its March lows, the Federal Reserve's take on the economy's strength and what looms ahead will be watched closely. The Fed will be releasing its statement Wednesday at 2:15 pm after concluding its two-day meeting.
"Right now we're at another phase — the stabilization phase. It's an inflection point," said Quincy Krosby, general market strategist at Prudential Financial Services. "The one thing the Fed does not want to do is abort the recovery."
Some gentle words of encouragement could help rejuvenate a market that has pulled back over the past several trading days due to profit-taking and concerns about the economy's strength.
"Are they going to say that growth is gangbusters? No, they're not going to say that," Krosby said. "But they must acknowledge that we have moved into a more stable situation."
The economy itself continues to show conflicting signs. While the unemployment rate has taken a mild downturn, most economists think the slight dip was only temporary and joblessness will rise more before it falls.
At the same time, the latest National Federation of Independent Business survey saw confidence slipping among its members, while consumer confidence actually grew in August, according to another survey.
Amid such uncertainty, investors may turn to the Fed for something a bit firmer to grab onto.
"Raising interest rates now would potentially stifle whatever recovery we have going," said Peter J. Tanous, president and director of Lynx Investment Advisory in Washington, D.C. "The market would like to hear some optimism."
Waiting for Rates to Rise
Hiking the central bank's key lending rate from its current target of zero to 0.25 percent indeed would be one way the Fed could put the brakes on the current rally. The market slump that led stocks to lose more than half their value from October 2007 to March 2009 was created largely from a crisis in liquidity, and any measures to cut the flow of money likely would be deadly to the rally.
To be sure, though, there's a strong sense that the Fed will begin tightening at some point, the main question being when that will happen.
The language from Wednesday's statement could be the first clue.
"Just by the wrong words, just by a tilt in their statement, they can have the market already start tightening for them," Krosby said. "Until the Fed believes that we have turned the corner on unemployment, I think that they're going to be very, very careful with their words."
It's not that the market doesn't know what's coming. In fact, most portfolio advisers know that within the next year or so rates are likely to go up, perhaps significantly.
Some think the seeds for a rate increase could be planted at this week's meeting.
"We don't think they'll raise but we do think that they'll signal they would like to raise, and probably begin to towards the end of this year," John Lekas, CEO at Leader Capital, said in a CNBC interview. Lekas said he sees the rate hitting as high as 7.5 percent by the second quarter of 2011.
"When the Fed starts raising interest rates, which probably won't be until the middle of next year, they've got a long way to go and will perhaps surprise people by how quickly they move up," added Michelle Girard, senior economist at RBS. "We think we'll be at 5 percent by the end of 2010 and continuing to move higher somewhat in 2011."
There's actually some belief that until the Fed starts hiking rates, Wall Street won't be paying much attention to the central bank.
"I don't expect any surprises out of them," said Michael Cohn, chief investment strategist at Atlantis Asset Management in New York. "I think it's kind of a non-event."
When the Fed does start raising rates again, though, it will mean two things are happening: the economy is accelerating again, and the central bank is in fact concerned that it could become overheated.
If nothing else, that surely will be a point when investors will pay heed.
"When the market perceives the Fed has a decision to make, that decision will be to raise interest rates," Tanous said. "Then the Fed will be important."
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