PREVIEW-Data downdraft puts clamp on Fed exit chatter

* WHAT: U.S. Federal Reserve monetary policy decision

* WHEN: Around 2:15 p.m. (1915 GMT) on Wednesday.

REUTERS FORECAST:

The Federal Reserve is expected to hold interest rates in
its current zero to 0.25 percent range on Wednesday at the end
of its two-day policy meeting. Most analysts expect the central
bank to hike interest rates in 2010, but not until mid to late
year, according to a Reuters poll. For details, click on
(FED/R: ).

FACTORS TO WATCH:

The Federal Reserve is clearly keen to begin retreating
from its extraordinary support to the financial system but a
wobbly U.S. economy is not cooperating.

After a two-day meeting that ends on Wednesday, the Fed
will almost certainly reiterate its commitment to keeping
interest rates at rock bottom lows for an “extended period.”

Weak holiday retail sales, ongoing pain in the job market
and further setbacks in housing has dampened talk of any
near-term rush for the doors.

Policy-makers will most likely choose to not only leave
benchmark overnight rates at their current range of zero to
0.25 percent, but are also likely to largely leave their policy
statement unchanged. The statement is due at around 2:15 p.m.
(1915 GMT) on Wednesday.

There has been lots of talk the Fed may soon raise the
discount rate it charges banks for direct loans. Such a step,
however, is seen as risky at this juncture because it might be
seen as the opening salvo of a tightening cycle and could
elicit an abrupt financial market reaction.

If anything, there might be a bias to the downside in the
Fed’s tone, particularly after December existing home sales
showed the biggest ever one-month decline.

Another important consideration is the central bank’s $1.43
trillion mortgage-buying program, which is scheduled to end in
March. The Fed has explicitly left the door open to more
purchases, but has also signaled that it would not likely take
action unless mortgage markets suffered a severe disruption.

The following are some scenarios to keep in mind, in order
of likelihood. All of the possibilities refer to changes in the
statement, since forecasters look at the steady rates picture
as a fait accompli:

MARKET IMPACT:

NO SUBSTANTIVE CHANGE

Probability: Most Likely

Market reaction: Firmer stocks, weaker bonds, dollar
steady

Policy-makers gave themselves enough wiggle room in their
last pronouncement that they could very well make only minor
tweaks to their last policy statement. In December, they
discussed the constraints on household spending as including a
“weak labor market, modest income growth, lower housing wealth,
and tight credit.” Not much of that has changed. This is
especially true after last week’s hit to the stock market,
which had its biggest three-day fall in 10 months and raised
concerns about the sustainability of the rally. “We don’t think
the tone of the growth discussion will change all that much, as
the intermeeting data have been in line with, or slightly
below, expectations,” said Michael Feroli, an economist at
JPMorgan.

DOWNBEAT SLANT

Probability: Somewhat Likely

Market reaction: Weaker stocks, firmer bonds, dollar
selling

Since the last Federal Open Market Committee meeting in
mid-December, the flow of economic data has been distinctly
negative. While fourth quarter GDP out later this week is
expected to show a robust 4.6 percent rate of growth, that
performance looks to have petered out in December and January.
Holiday retail sales proved underwhelming, while sales of
existing homes fell a stunning 16.7 percent in December.
Industrial production also softened after a string of gains.
“The meeting takes place against the background of a sharp
pickup in real GDP growth in the fourth quarter, but much less
encouraging high-frequency numbers released over the past few
weeks,” Goldman Sachs economists noted in their research. “This
is likely to preclude serious consideration of an ‘exit.'”

BULLISH TILT

Probability: Least Likely

Market reaction: Toss-up for stocks and bonds, dollar
rallies

Despite a surprisingly weak labor market, many Wall Street
economists believe the sheer momentum of the inventory cycle —
in which depleted stocks need to be replenished to meet demand
— will drive the economy to solid growth rates this year. Talk
of better-than-expected GDP readings, until recently, abounded.
In this light, the Fed could choose to focus on the bright
side. Investors would then rush to price in a near-term
tightening, giving an emboldened dollar further reason to march
higher.

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PREVIEW-Data downdraft puts clamp on Fed exit chatter