Yellen's farewell at the Fed has become more complicated

AP/Evan Vucci

• The Federal Reserve is widely expected to raise interest rates on Wednesday, and the Fed chair, Janet Yellen, is set to hold her final press conference.
• Less certain is what the Fed forecasts for 2018.
• Republicans are much closer than they were at the Fed's September meeting to passing tax cuts.
• How the Fed factors this into its economic forecasts for next year will be key to watch.

The Federal Reserve later on Wednesday is widely expected to announce a third and final interest-rate hike of the year.

Its statement, out at 2 p.m. ET, is expected to show that the Federal Open Market Committee decided to raise the federal funds rate by 25 basis points to a range of 1.50% to 1.75%.

"There have been two significant developments since the last set of FOMC forecasts were released at the September FOMC meeting," Lewis Alexander, the chief economist at Nomura, said in a recent note.

First, economic data has been stronger than forecasters generally expected.

Second, and perhaps more important, the GOP is much closer to passing tax cuts. That has changed the outlook for fiscal policy, which is beyond the Fed's control.

"It remains unclear exactly how many FOMC participants will incorporate increasing prospects for fiscal expansion into their forecasts," Alexander said. But it could prompt some FOMC members to raise their forecasts, he added.

The dot plot, which shows where FOMC members think interest rates would be over the next few years, could increase by 12.5 basis points on average for 2018 and 2019, said Michael Gapen, the chief US economist at Barclays, in a note. "Further upward adjustment will likely have to wait until either the tax cut passes or there is sufficient evidence to suggest that inflation is firming faster than anticipated," Gapen said.

Yellen out, Powell in

Since Wednesday's rate hike is widely expected, markets are looking ahead to what the Fed says, or hints, about 2018.

One thing's for sure: Fed Chair Janet Yellen will leave the helm in February when her four-year term ends. Jerome Powell, President Donald Trump's nominee to replace her, is likely to receive Senate confirmation following a 22-to-1 acceptance from the Senate Banking Committee.

Though the Fed leadership is changing, Powell's appointment represents a continuation of the steady policy approach that Yellen has used in what's set to be one of the least volatile tenures.

She'll leave the Fed without overseeing a financial crisis. Over the past four years, the unemployment rate has fallen to 4.1% from 8%; the Fed hadn't expected the unemployment rate to be that low until 2018.

But inflation has remained stubbornly low and below the Fed's 2% target, owing to what Yellen has at several times attributed to temporary factors including weak oil and cellphone-plan prices.

"Getting back to 2% inflation by the end of next year is not going to be too difficult as these one-time surprises come out," Peter Hooper, the chief economist at Deutsche Bank, said at a media briefing on Tuesday. "What we'll be looking for in the statement is, Is there any change in what they've called 'soft core inflation' recently?"

That's an important signal for whether the Fed raises rates in March, Hooper said.

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