Fed likely to calm markets before raising rates

With the Federal Reserve on Wednesday expected to guide expectations for a rise in interest rates, economists say the central bank will balance the move with assurances aimed at preventing a market sell-off.

In a statement following a two-day meeting that begins today, the Fed is likely to drop a promise to be patient as it weighs interest rate hikes, clearing a path for an increase as early as June based on recent Fed guidance. The Fed's benchmark rate has been near zero since the 2008 financial crisis.

Although financial markets are anticipating the change, investment manager Patrick Maldari of Aberdeen Asset Management still expects a "hiccup" that drives down the Dow Jones industrial average by up to 200 points and raises yields on short-term bonds as much as 40 basis points.

To minimize the damage, economist Michael Hanson of Bank of America says Fed policymakers may emphasize that they will only "gradually" raise rates and that Fed policy will remain "highly accommodative (to economic growth) for some time after liftoff."

In her press conference, Fed Chair Janet Yellen is likely to stress that June is simply the earliest possible time frame for a rate increase and that it could come later, echoing her recent congressional testimony, says JPMorgan economist Michael Feroli. Yellen, he says, is also likely to note that the pace of subsequent rate increases "is more consequential than the exact timing of liftoff."

Instead of a steady, measured pace of increases, Yellen could suggest that the Fed will closely monitor economic data and may pause, leaving rates unchanged at some meetings, Feroli says.

The Fed is struggling to respond to a torrid labor market but weak inflation and tepid economic growth that are prompting some Fed policymakers to balk at raising rates.

Key to watch: the Fed's updated forecasts for the unemployment rate, inflation and growth. All are expected to be revised down slightly, but if 2016 projections for core inflation — excluding food and energy — are marked down substantially, that likely would signal a later rate hike.

Goldman Sachs economist David Mericle says it would indicate policymakers are not "reasonably confident" of inflation rising toward the Fed's annual 2% target over the medium term — a criterion Yellen has said is essential for a rate increase. Yellen expects inflation to pick up as oil prices drift upward and the dollar's appreciation slows.

While many economists are forecasting a June rate hike, Mericle is among those predicting the Fed will act in September because he believes its preferred measure of core inflation will drop from 1.3% to 1.1% by midyear.