NEW YORK (CNN/Money) - Instead of cutting or raising interest rates, Federal Reserve policy-makers will walk a high-wire act next week, trying to balance cautious optimism about the economy with a need to convince bond investors that they plan to keep rates low for quite some time.
Led by Chairman Alan Greenspan, the Federal Open Market Committee (FOMC), the central bank's policy-making arm, is scheduled to meet Tuesday morning to hash out the state of the economy and the direction of interest rates.
Few economists expect the Fed to cut or raise the federal funds rate, an overnight bank lending rate that influences other key bank rates. But the statement announcing their decision to do nothing will be closely followed by economists for hints on future moves by the central bank.
Will the Fed focus on signs of economic improvement, at the risk of sending financial markets into a feeding frenzy over when the central bank may start to raise interest rates, or will they keep painting a mixed picture of the economy, at the risk of appearing too glum?
"I think their general view will be more upbeat, but it remains to be seen how upbeat, because they don't want to cannibalize their main message, which is that policy will remain accommodative for a considerable period," said Anthony Crescenzi, bond analyst at Miller Tabak & Co.
Sizzling economy -- but no jobs yet
Translation: the Fed hopes to keep rates low for a long while to give the job market a chance to improve along with the rest of the economy.
The central bank cuts rates to keep borrowing cheap and spur economic activity, and it raises them to cool the economy off and keep inflation at bay. The Fed started cutting rates in January 2001 due to early signs of the recession that began in March and ended in November of that year, according to the National Bureau of Economic Research.
After eleven cuts in 2001, the Fed cut short-term rates again in November 2002 and June 2003, as the economy stumbled through a stop-and-start recovery, battered by terror attacks, corporate scandals, stock-market weakness, the war with Iraq and other woes.
Though consumer spending has stayed strong, business spending and factory output has been spotty, and the labor market has stubbornly refused to heal.
But recently, fueled in part by child tax credit checks and money from mortgage refinancings, consumer demand has accelerated, manufacturing output has increased to match it, and most economists hope this surge in activity will finally spur hiring and job growth.
The latest "Beige Book" survey from the Fed, its periodic report card on the economy, echoed this more optimistic view, citing improvement in business activity and a "firming" of demand for workers in manufacturing and other sectors.
"We're looking for the wording of the Fed's statement to change in an encouraging direction. The economic numbers would argue for more optimism than caution at this point," said Sung Won Sohn, chief economist at Wells Fargo & Co. "My expectation is that this economy will be sizzling in the third quarter and hopefully in the fourth quarter, and that should lead to more jobs."
But the job growth is still a promise rather than a reality -- payrolls fell again in August, and the number of weekly jobless claims has crept back above the 400,000 level, a sign of labor-market weakness.
Fed Governor Ben Bernanke -- a voting member of the FOMC -- has said in recent speeches that it could be several months before the stronger economy creates jobs and inflation.
Bernanke's view was echoed by that of San Francisco Fed President Robert Parry, also a voting FOMC member, and both bankers hinted that another rate cut was not out of the realm of possibility, if jobs didn't start growing soon.
Bend it like Bernanke?
The only question is whether their views -- which are more cautious than those expressed lately by Greenspan and in the Fed's latest "Beige Book" -- will filter into the Fed's statement.
"It wouldn't surprise me if the Fed did stick with the positive and ignore the negative, but I can't imagine them taking out the statement [in their August policy announcement] that says 'labor market indicators are mixed,'" said former Fed economist Lara Rhame, now a senior economist with Brown Brothers Harriman. "If they are positive, they still have to retain at least that one negative."
This spring, the Fed's bearish statements about the economy helped encourage long-term rates to fall in the bond market, as investors bet that rates would stay low for a long time.
But subsequent bullish statements from the Fed, along with a smaller-than-expected cut in short-term rates in June, caused investors to believe the Fed was through cutting rates and might even start raising them sooner than some had expected. As a result, bond yields jumped, and Bernanke and other Fed officials began to worry that might hurt the budding pickup in economic growth.
Bernanke's recent bearish statements have helped fuel fresh buying in the Treasury market, driving rates lower again, and the Fed might be loathe to cause yet another reversal by being too sunny in its statement. Bond prices and yields move in opposite directions.
"People are looking towards their remarks about how the economy is doing, and I think they will be more specific on that," said Rajeev Dhawan, director of the Economic Forecasting Center at Georgia State University in Atlanta. "The Fed will probably tailor its remarks to build the expectation that it will be a while before they raise rates."