By Nick Timiraos 

Federal Reserve officials are likely to hold interest rates steady and maintain their wait-and-see policy stance after their two-day meeting ends Wednesday.

They cut rates three times last year, lowering their benchmark federal-funds rate to a range between 1.5% and 1.75%, after raising it four times in 2018.

Officials are likely to discuss several important behind-the-scenes policy considerations this week, but aren't expected to decide on any immediate action.

The Fed releases its policy statement at 2 p.m. ET, and Fed Chairman Jerome Powell will deliver a longer statement and answer questions from reporters starting at 2:30 p.m. Here's what to watch:

Economic Outlook

Since Fed officials' December meeting, financial markets had been ebullient due to a trade truce between the U.S. and China and glimmers of firmer global manufacturing activity. But fears about China's coronavirus outbreak reignited global growth worries in recent days, sending the benchmark 10-year Treasury yield earlier this week below 1.6%, its lowest level since October.

Officials are likely to make just minimal changes to their policy statement, leaving Mr. Powell to convey any nuances about how they view the growth outlook.

While they are holding rates steady for now, they have signaled they see greater risks of surprises that could force them to lower rates than to lift them. The coronavirus is the latest example of such a development.

Mr. Powell has essentially ruled out reversing last year's rate cuts for the foreseeable future by saying he would want to see a persistent and sustained rise in inflation before lifting rates. The Fed staff doesn't forecast this happening for several years.

Reserve Balances

With rates on hold, the focus at this week's meeting shifts to officials' progress -- or lack thereof -- in fine-tuning their control of short-term rates.

Fed officials avoided a much-feared spike in overnight lending rates at the end of the year, a sign that flooding cash markets with plentiful loans has worked for now. The question they now face is what amount of bank deposits held at the Fed, called reserves, they think will be needed once they curtail their current lending operations and their purchases of Treasury bills.

Buying Treasury bills is designed to rebuild reserves that officials think fell too low last September. They have suggested they will eventually transition from their current monthly pace of $60 billion in purchases to a lower level -- around $10 billion or $15 billion, according to private-sector analysts -- to keep up with normal currency growth.

How long they continue their market interventions will depend on the quantity of reserves officials want to maintain in the system. Officials haven't answered this critical question publicly, with Mr. Powell instead saying the level of reserves should be no lower than $1.45 trillion.

Reserves are currently slightly more than $1.6 trillion, but only because of Fed bill purchases and lending in a key market for secured debt called repurchase agreements.

What to Call It

Mr. Powell has said repeatedly that bill purchases aren't the same thing as the Fed's post-2008 policies to stimulate growth by buying Treasury securities and mortgage bonds, called quantitative easing or QE. But a market rally from October until January led commentators to argue that the purchases are akin to QE.

The debate over this matters because if investors believe these policies are providing support to financial markets, that could complicate efforts to phase them down this spring or summer. Given market sensitivity to balance sheet policy in the past, investors are likely to closely follow how Mr. Powell addresses these questions in his press conference.

Technical Adjustment

The Fed's market interventions have pinned the effective fed-funds rate near the bottom of its range, at 1.55%, which matches a separate rate the Fed pays banks on reserves.

When the banking sector was awash in reserves, the Fed set the rate on reserves at the top of the fed-funds range. But as the Fed drained reserves from the system between 2017 and 2019, the fed-funds rate traded slightly higher in the range. Twice in 2018 and twice last year, the Fed lowered the interest rate on reserves relative to the top of the fed-funds range, each time by 0.05 percentage point, to keep fed-funds trading well within the middle of its range.

A top Fed manager flagged the possibility at their December meeting that officials at some point would need to lift the interest rate on reserves by 0.05 percentage point to keep the fed-funds rate in the middle of the range. This would reverse the most recent cut officials made to the reserves rate in September, when very short-term lending rates spiked because banks were reluctant to lend reserves.

Most analysts expect the Fed to increase this rate, but it is an open question whether it will do so Wednesday or revisit the question at its next meeting in mid-March. If the Fed does lift the interest rate on reserves, Mr. Powell is likely to say that the decision is purely technical, as he has done every time they adjusted it previously.

Framework Review

The Fed is likely to continue discussions on the review of its inflation-targeting framework, but conclusions aren't expected for several more months. Given the continuing review, officials decided last month not to release their annual statement on longer-run policy goals this week, as they typically do every January.

Write to Nick Timiraos at nick.timiraos@wsj.com

(END) Dow Jones Newswires

January 29, 2020 05:44 ET (10:44 GMT)

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