The U.S. Federal Reserve is gearing up for a two-day policy meeting that begins on Tuesday, and the consensus among experts is that they will maintain the current interest rates while shedding light on their future monetary policy direction before the year's end.

At 2 p.m. EDT on Wednesday, the Federal Reserve will release a new policy statement and its interest rate decision. Following this, Fed Chair Jerome Powell will provide further insights during a press conference at 2:30 p.m.

For those invested in contracts tied to the federal funds rate, it's almost a sure bet that the U.S. central bank will leave the benchmark federal funds rate untouched, retaining its current range of 5.25% to 5.5%. This aligns with the Fed's recent shift towards a more measured and deliberate approach to raising interest rates.

From March 2022 to May 2023, the Fed raised rates at ten consecutive meetings, with incremental increases ranging from a quarter to three-quarters of a percentage point. This aggressive strategy was employed to combat the highest inflation rates since the early 1980s.

However, in June, the Fed paused this rate-hiking spree. Even though 12 out of 18 policymakers had previously projected two more quarter-point rate increases by the end of the year, one of those hikes occurred at the July meeting.

While the Fed's new "data-dependent" approach may imply that they'll skip a rate increase in September, recent economic data hasn't provided a compelling reason for policymakers to take that final rate hike off the table. Furthermore, although inflation has receded from its peak last year, underlying measures indicate that prices are rising at roughly double the Fed's target of 2%.

Policymakers, especially Powell, have been determined to combat inflation, even if it results in higher interest rates than initially anticipated. This approach poses a greater risk to an economy that has already exceeded expectations regarding job creation and growth amidst the rapid tightening of monetary policy.

A higher Fed rate tends to prompt banks and financial institutions to raise their rates for various forms of financing, such as home mortgages, business loans, and credit cards. This, in turn, discourages investments and household spending, potentially curbing inflation through reduced demand.

If the Fed were to close the door on further rate increases now, it could lead to looser overall financial conditions as markets anticipate a lower rate trajectory, which runs counter to the Fed's goals while the containment of inflation remains uncertain.

The outcome of Wednesday's meeting may necessitate a challenging shift in communication as the Fed navigates the approach of what is likely the end of its rate hikes (any further rate hike would probably occur at the November meeting). This transition also marks the impending shift towards lowering interest rates next year to align with decreasing inflation.

Revised economic projections are expected to indicate progress on price stability this year and next. This will gradually push the inflation-adjusted "real" interest rate higher unless the policy rate is simultaneously reduced.

The speed and timing of such reductions remain a topic of debate within the Fed, hinging on the pace of inflation decline. In June, officials anticipated a full percentage point drop in the policy rate next year, coinciding with decreasing inflation and rising unemployment. Market observers will scrutinize this outlook closely for any alterations, as it reflects the economy's underlying strength.

Bank of America analysts speculate that the Fed may anticipate a smaller rate cut next year, possibly three-quarters of a point, while potentially revising the long-term estimate of the neutral policy rate slightly upward. This adjustment would imply a need for a tighter monetary policy to exert the same restraint on businesses and households over time.

This reconciles some of the data observed by the Fed this year, such as the economy's growth consistently surpassing the central bank's potential estimate despite rate hikes. However, it could also mean that interest rates remain higher for longer than the public anticipates.

In summary, recent data leaves the Fed optimistic about ongoing disinflation but concerned about a potential resurgence in inflation due to strong economic activity. Consequently, the risks are tilted towards interest rates remaining higher than expected through 2024.