By Howard Schneider

WASHINGTON (Reuters), Despite having a clearly defined strategy to combat high inflation, U.S. Federal Reserve officers now face fresh evidence that coronavirus may be slowing down the economy, as well as market conspiring with Fed policymakers to tighten financial conditions more quickly than they might have hoped.

This combination of investors and economic data could cause unexpected complexity at the Fed’s next-week meeting. Policymakers are trying to find a balance between continued uncertainty regarding the health crisis and market adjustments fast to the Fed’s inflation projections.

At its December meeting, every official anticipated at least one rate rise and nearly half of them expected three. The central bank also stated that the reserve would be reducing its $9 trillion assets to aid in tightening monetary policy. They were able to refining their message that a March interest rate hike would be followed by a reduction in balance sheets later in the year at the next session.

The stakes have increased.

Recent retail spending data https://www.reuters.com/article/usa-economy-idTRNIKBN2JO1G9 were disappointing, real-time measures of economic activity have dipped, and hiring may have eased in response to the massive wave of coronavirus infections driven by the Omicron variant.

The daily pace of infections https://tmsnrt.rs/3FPZXio may now be slowing, but other risks to the recovery remain, including a decline in federal government spending that has helped support disposable income for families throughout the pandemic.

Data from payroll provider UKG showed shift work decreased by 5% for the week ending Jan. 16 compared to the week before, a sign coronavirus infections may produce another disappointing employment report in January after job growth of just 199,000 https://www.reuters.com/article/usa-economy-idTRNIKBN2JH0AR in December.

Oren Klachkin from Oxford Economics said that the recovery “weakened more” in the beginning of this year. The indicators for employment were lower than they were prior to the holidays. This was due to the Omicron virus “dragging down employment.” After hitting 100 in October, the index of recovery was slipping over recent weeks.

Fed officials hope the impact of the pandemic on the economy will diminish soon. But, until that happens it will be difficult to know if the Omicron strain will fall in the United States at the same rate it did in South Africa or elsewhere.

Joseph Lavorgna, chief economist at Natixis, said that signs of slow growth are being treated by the Fed as temporary and attributed entirely to Omicron disruptions. This would be an error. This year will see a significant tightening in fiscal conditions. The rise of interest rates to a slowdown in growth raises the risk” that Fed policy could slow down growth and trigger a recession.

MARKETS ABUZZ

Next week’s meeting will be held on Tuesday and Wednesday. The challenge is not to admit the risks of the virus to the economy, but to maintain a commitment to fighting inflation. Or, to the contrary, to appear so worried about the prices that investors are expecting even more strict policies.

Investors have so far accepted the Fed’s agreement on rate increases and followed it. The interest rate futures market has strong odds of five rate hikes this year, with a quarter percent point per rate. Real-world borrowing costs have risen for those looking to purchase a home. Corporations seeking capital raises and the U.S. government also have seen their rates rise. U.S. stocks fell sharply in the first quarter of this year due to concerns that rising rates would impact technology and growth share.

There is a lot of speculation in the markets that the central bank will make history by raising its half-point interest rate for the first time in over 20 years. The chatter has sparked rumors about how it might begin to reduce its reserves faster than predicted and tighten credit conditions even further.

Fed officials are aware that the central bank cannot move at a speed too fast without creating a backlash on financial markets, which can slow down spending and increase hiring.

Chris Waller, Fed Governor of Chris Waller was asked if the Fed might raise interest rates by half an percent in March as some sort of shock treatment for inflation.

Waller said last week on Bloomberg TV that “we haven’t prepared markets for anything so dramatic”.

The Fed finds itself in a difficult situation.

Since at least ten years, policymakers in the present generation have been concerned primarily about low inflation. They are not experts in lower it.