The Federal Reserve is widely expected to hold interest rates steady this Wednesday during the central bank’s last policy meeting of the year.

It is also expected to caution against making rate cuts anytime soon, defying the expectations of some on Wall Street who expect that easing to happen as early as March.

Market observers are eager for any sign that the most aggressive rate-hiking campaign since the 1980s is over.

"Raising the Fed funds rate is off the table," Wilmer Stith, bond portfolio manager for Wilmington Trust, said. "The issue is how long are we going to be at 5%?"

Luke Tilley, chief economist at Wilmington Trust, predicts the Fed will hint it may have reached the peak on rate hikes.

"I expect there will be some couched language that says we've reached a level of restrictiveness and continuing to turn towards the question of how high for how long," he said.

The Fed last hiked rates in July and has elected to keep interest rates unchanged the past two policy meetings in a range of 5.25%-5.50%, a 22-year high.

Read more: What the Fed rate-hike pause means for bank accounts, CDs, loans, and credit cards

Inflation, which the Fed is trying to cool, continues to drop closer to the central bank’s 2% target. The Fed’s favored inflation measure — the core Personal Consumption Expenditures index, which excludes volatile food and energy prices — clocked in at 3.5% for the month of October, down from 3.7% in September and 4.3% in June. The Consumer Price Index on a core basis showed inflation rose 4% in November, the same clip as in October.

Inflation has now fallen below where the Fed expected it to end the year.

While many Fed officials are feeling more comfortable that rates are likely at the right level to bring down inflation, most are still keeping the option of another rate hike on the table and suggesting rates will remain elevated for some time. One has even said more hikes are still expected.

Fed Chair Jerome Powell is also expected this Wednesday to strike a hawkish tone, similar to the message conveyed in his address at Spelman College earlier this month when he warned investors not to assume the Fed is finished raising rates and will soon turn to cutting.

"It would be premature to conclude with confidence that we have achieved a sufficiently restrictive stance, or to speculate on when policy might ease," he said on Dec. 1, adding that the central bank is prepared to "tighten policy further if it becomes appropriate to do so."

One reason Powell may choose to talk tough on inflation this week, Fed observers say, is because financial conditions have loosened recently after long-term bond yields soared rapidly this fall.

The yield on the 10-year Treasury hit 5% in October but has come back down to around 4.25% — exactly where it was in early September. Meanwhile the stock market is also roaring higher. The S&P 500 (^GSPC) is up nearly 20% this year and the Nasdaq Composite (^IXIC) has gained nearly 38%.

"Powell is going to err on the side of being a little hawkish," said Stith. "They're going to try to build more of a wall up that conveys we're higher for longer."

This Wednesday Fed officials could temper expectations for rate cuts in 2024 when an updated version of interest rate expectations is released. The so-called dot plot could show fewer rate cuts for next year, which members already curtailed in September.

Forecasts on inflation, GDP growth, and unemployment will also be released.

Wall Street is pricing in a near 100% chance rates are left unchanged Wednesday while also pricing in the chance for a rate cut as soon as March.

'Somewhat misplaced'

Tilley, the chief economist at Wilmington Trust, expects a full percentage point of rate cuts starting next spring.

He also expects Fed officials to pencil in three-quarters of a percentage point of more rate cuts in 2024 but stop short of a full percent so as not to loosen financial conditions further.

Goldman Sachs chief economist Jan Hatzius is another observer who now predicts that falling inflation will prompt the Fed to begin cutting in the third quarter next year, earlier than he previously thought.

Hatzius expects nearly a full percentage point in rate cuts next year, but said Fed officials will pencil in two rate cuts next year and 125 basis points of rate cuts in 2025.

Not all observers agree on what the Fed will do next year. James Fishback, founder and chief investment officer at hedge fund Azoria Partners, said the market is "way ahead of its skis" in terms of pricing rate cuts in 2024.

Fishback maintains that half a percentage point of rate cuts next year was conditioned on the Fed hiking at Wednesday’s meeting. Officials penciled in one more rate hike this year in September, which they aren't expected to execute.

Fishback said holding rates at the current level can act as a form of tightening.

"By December of next year, the market has priced in over 100 basis points of cuts," he said. "If the Fed simply holds the line and cuts once, they will have delivered in essence three rate hikes relative to market expectations, exerting more tightening pressure on the economy."

Stith also said he thinks inflation is still too high for the Fed to move off the current level of rates any time soon.

"The market is always coming back to the narrative of 'if we're going to have a slow growth or no growth at all, the Fed is gonna come in and rescue the economy,'" he said.

"That's where I think the market's expectations are somewhat misplaced, particularly given where inflation is and where the Fed is just trying to get inflation to go."

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