Fed seen trimming bond buys, could offer vague rate clues

By Michael Flaherty

WASHINGTON (Reuters) - The U.S. Federal Reserve on Wednesday looks certain to press forward with its plan to wind down its bond-buying stimulus, and could offer some vague clues on how much nearer it might be to finally raising interest rates.

The central bank is widely expected to cut its monthly asset purchases to $25 billion from $35 billion, which would leave it on course to shutter the program this fall.

With little drama expected from the decision, and no fresh economic projections or news conference to guide investors, financial markets will be left to scour the Fed's announcement for any hint on whether officials are growing more anxious to start to reverse their monetary accommodation.

The Fed has kept overnight interest rates near zero since December 2008 and has more than quadrupled its balance sheet to $4.4 trillion through a series of bond purchase programs.

However, with unemployment dropping and inflation firming, the Fed could suggest the days of this monetary largesse are increasingly numbered. The government on Wednesday said the U.S. economy grew at a 4 percent annual rate in the second quarter, which could bolster the hand of officials within the central bank who have begun pushing for a rate hike sooner rather than later.

"It is possible that the Fed will begin to alter its view on how much slack remains in the labor market," Paul Dales, of Capital Economics, said in a research note.

After its last meeting six weeks ago, the Fed said unemployment "remains elevated." Since then, the jobless rate has fallen to a near six-year low of 6.1 percent.

JPMorgan economist Michael Feroli said in a research note that the central bank could modify its language to say "somewhat elevated." Such a change would allow the Fed "a more gradual pivot in communications toward recognizing they are making progress toward their mandate," he said.

To a good degree, the health of the labor market holds the key to the Fed's decision on rates.

Fed Chair Janet Yellen believes there is more slack in the jobs market than the unemployment rate alone would suggest, but she warned earlier this month that a rate hike could come "sooner and be more rapid than currently envisioned" if labor markets continue to improve more quickly than anticipated.

Payrolls processor ADP said on Wednesday U.S. companies hired 218,000 workers in July, a solid pace but a bit short of economists' forecasts.

A more comprehensive government report on Friday is expected to show nonfarm payrolls increased by 233,000 in July, which would mark the sixth straight month with job growth above 200,000.

After a stronger-than-expected reading on employment early this month, the median forecast of economists polled by Reuters put the first increase in rates in the second quarter of next year. Previously, it had been the third.

The forecast is in line with the prediction offered by interest-rate futures, which imply an increase in June 2015.

Officials could also acknowledge a modest uptick in U.S. prices, which has put inflation closer to the central bank's 2-percent target. Indeed, during the second quarter, inflation logged in at a 2 percent rate.

But economists expect the Fed to hold fast to its guidance that a "considerable time" will elapse between the end of its bond buying and its first rate hike.

(Reporting by Michael Flaherty; Editing by Andrea Ricci and Meredith Mazzilli)