The Federal Reserve signaled that it would start raising interest rates steadily in mid-March, the latest move to remove stimulus to bring inflation down.
Fed Chairman Jerome Powell said on Wednesday that the central bank was ready to raise interest rates at its meeting on 15-16. March and could continue to raise them faster than it did over the past decade.
“This is going to be a year where we are constantly moving away from the very accommodating monetary policy that we have put in place to deal with the economic effects of the pandemic,” he told a news conference following a Fed political meeting.
Shares were sold while he was talking, and the return on 10-year government securities rose as investors expected a more aggressive path for interest rate increases.
Mr. Powell left the door open to raise interest rates at subsequent political meetings, which are held about every six weeks. This is something the Fed has not done since 2006.
“I do not think it is possible to say exactly how this is going to go,”[ads1]; he said. Earlier, Mr Powell said: “I think there is quite a lot of room for raising interest rates without threatening the labor market.”
Mr. Powell’s remarks led investors in fixed income markets to fully predict an interest rate hike in March of at least a quarter of a percentage point and a nearly 70% chance of a second rate hike at the Fed’s meeting after that in early May, according to CME Group.
Mr. Powell suggested that the central bank was unlikely to offer any future guidance, or the words officials use to describe their intentions with interest rates over the next few years, which have been a key part of Fed policy.
In 2015, the Fed prepared the markets for a mild path with no more than one quarterly rate hike, saying that increases would be “only gradual”.
Mr. Powell’s message on Wednesday was that compared to the rate hikes in that cycle, “we need to be prepared for a faster pace and for more comprehensive measures to be taken during the year,” said Kristina Hooper, head of the global market. strategist at Invesco.
Relying less on forward-looking guidance means that “you risk changing market expectations” about interest rates, said Vincent Reinhart, a former Fed economist who is now chief economist at Mellon.
The central bank also approved a final round of asset purchases, which will bring the stimulus program to an end by March. Officials continued to discuss at their two-day meeting how and when to shrink the Fed’s $ 9 trillion portfolio, which has more than doubled since March 2020.
The Fed issued a separate one-page statement specifying high-level principles to lead a process to “significantly reduce” these holdings.
The Fed weighs interest rate increases
In 2020, the central bank cut short-term interest rates to close to zero and began buying bonds to lower long-term interest rates as the coronavirus pandemic hit the US economy, triggering financial market volatility and a deep, short-term recession.
Officials promised to keep interest rates close to zero until inflation was forecast to moderately exceed 2% and until the labor market returned to levels corresponding to maximum employment. Mr. Powell indicated that he and his colleagues believe these goals have been achieved.
High demand for goods and a shortage of intermediates such as semiconductors have pushed inflation to the highest 12-month level in decades. Consumer prices rose 5.7% in November from a year earlier, according to the Fed’s preferred measure, and easily exceeded the Fed’s first target.
It has been developments in the labor market that have given greater urgency in recent weeks for the Fed to accelerate plans to raise interest rates much faster than officials expected last summer.
Strong wage growth and a historic fall in unemployment during the second half of last year – to 3.9% in December from 5.9% in June – led officials on Wednesday to say that their employment-related targets had also been reached.
Fed officials face a difficult task of responding to high inflation with two different policy instruments, which may provide more ammunition to slow the economy, but which have previously created confusion in the markets.
Mr. Powell indicated that they would again choose to passively liquidate their assets on a telegraphed plan after raising interest rates. It will allow the process, in which the Fed no longer reinvests revenues from maturing securities in new ones, to operate “sometime in the background,” Powell said. In this way, adjustments to its short-term reference rate, the federal funds rate, remain the primary way in which officials react to changes in the economic outlook.
The prospect of more interest rate hikes and a shrinking Fed portfolio to reduce inflation have led to increased market volatility in recent days, which has led investors to sell shares in some technology companies, cryptocurrencies and other risky assets that boomed last year.
The Fed’s turn to tighten policy “is definitely not a sudden revelation and has been more of an evolution, so why the market has been getting the message right now is a bit confusing,” said Tom Graff, head of interest rate and portfolio management at Brown. Advisory.
Mr Graff said markets had taken the Fed’s promises of tighter monetary policy more seriously after officials signaled earlier this month that they had begun considering plans to shrink the asset portfolio. “If your thesis was that a particular stock valuation made sense because interest rates were always going to remain extremely low, then it was on borrowed time,” he said.
For several months last year, Mr. Powell and his colleagues said they did not need to raise interest rates to bring down inflation because they believed high levels of inflation stemmed mainly from supply chain bottlenecks and other difficulties in reopening the economy.
Mr. Powell changed course in November, saying that the central bank was worried that inflation could be anchored. It set in motion a policy pivot that has been rapid under Fed standards, given its preference for moving slowly to avoid whipsaging markets.
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The pivot reflected a shifting calculation of the potential for stronger demand to push up prices such as wages and rents, which could keep inflation up even after bottlenecks and shortages of goods such as cars and trucks subside.
Officials place more emphasis on the prospect that the aggressive fiscal and monetary policy reactions to the pandemic changed traditional recession dynamics, and promoted wage growth, which normally takes longer to recover from a downturn.
Last month, civil servants cut interest rates by three quarters of a percentage point this year and three until next year. The estimates for the increases are based on a forecast that sees inflation fall to below 3% by December and to just over 2% by the end of next year.
Mr Powell said that since the Fed’s last meeting, inflation has probably been a little worse than expected. “To the extent that the situation worsens further, our policy will have to address it,” he said.
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