Fed Expects Rate Rise Citing Inflation and Job Growth
Faced with volatile financial markets and rising inflation, the Federal Reserve suggested that it may soon hike interest rates for the first time in more than three years as part of a broader tightening of historically loose monetary policy.
Even though inflation has been running substantially higher than policymakers' target levels and labor market data shows a labor shortage, Federal Reserve officials said on Wednesday that they were on track to raise interest rates in March.
Despite keeping interest rates near zero, where they have been since March 2020, central bankers warned that borrowing costs would rise "soon." The statement issued following their two-day policy meeting prepared the way for increased borrowing costs "soon." According to Fed Chairman Jerome H. Powell, officials no longer believe that America's rapidly improving economy needs as much assistance. He predicted that an increase in interest rates would be likely at the central bank's next meeting in December.
According to Powell, "given the current favorable conditions, I believe the committee is inclined to raise the federal funds rate at its March meeting."
While he declined to say how many rate hikes the Fed expected this year, he did point out that this economic expansion was unlike any other, with "higher inflation, higher growth, and a much stronger economy — and I think those differences are likely to be reflected in the policy that we implement," he added.
The Federal Reserve had already begun to scale back a bond-buying program to stimulate the economy. That program is slated to expire in March. The Federal Reserve's post-meeting comments and Mr. Powell's remarks hinted that central bankers might begin to reduce their balance sheet holdings of government-backed paper as soon as interest rates are raised, so taking support from the markets and the economy in the process.
In the face of significant labor shortages reported by businesses and rising prices across the economy — for rent, autos, and couches — the Federal Reserve has abruptly altered its focus from promoting growth to preparing to reduce it. Consumer prices are rising at the fastest rate seen since 1982, eroding incomes and posing a political risk for Vice President Biden and the Democrats in the White House. Maintaining inflation under control and laying the framework for a healthy labor market are the Federal Reserve's responsibilities, respectively.
According to market estimates, following the meeting, investors upped their expectations for rate increases and now expect the Fed to raise rates five times this year. According to market pricing, the policy rate is likely to be between 1.25 and 1.5 percent at the end of the year. The fear is that central bankers may act quickly, potentially hiking borrowing prices at each successive meeting rather than at intervals between meetings or in half-percentage point increments rather than the quarter-point increments that are more normal.
When asked about the pace of rate increases, Mr. Powell deferred, stating that it was critical to be "modest and flexible" and that "incoming data and the evolving outlook" would guide the Fed's decision.
According to Subadra Rajappa, head of U.S. rates strategy at Société Générale, "he went out of his way not to commit to any preconceived course of action." Because there is no way of knowing what will happen next "creates the conditions for a volatile market."
However, while interest rates are expected to rise in the next years, most economists and investors do not predict they will return to the double-digit levels experienced in the early 1980s. The Federal Reserve anticipates that its longer-term interest rate will be approximately 2.5 percent.
Investors have also been waiting with bated breath to see how quickly the Federal Reserve will shrink its asset holdings on its balance sheet of assets. The Federal Reserve's policy committee stated principles on Wednesday outlining plans to "significantly" shrink its holdings "in a predictable manner" and "primarily" by adjusting the amount of money it reinvests as assets expire.
Mr. Powell indicated during his news conference that two of the Fed's objectives — maintaining price stability and ensuring maximum employment — had prompted the central bank to "move steadily away" from its previous policy of providing significant stimulus to the economy.