Fed signals rate hike in March, citing inflation and strong labor market

Federal Reserve officials signaled on Wednesday that they were on track to raise interest rates in March, given that inflation was well above policymakers’ target and labor market data suggest a shortage of employees.

Central bankers left rates unchanged at near zero – where they have been set since March 2020 – but the declaration after their two-day policy meeting, they laid the groundwork for higher borrowing costs “soon”. Jerome H. Powell, the Fed Chairman, said officials no longer believe the recovering U.S. economy needed as much support, and he confirmed that a rate hike was likely when the next central bank meeting.

“I would say the committee is of the view that the federal funds rate should be increased at the March meeting, assuming conditions are appropriate to do so,” Powell said.

Although he declined to say how many rate hikes officials expected to make this year, he noted that this economic expansion was very different from previous ones, with “higher inflation, higher growth, much stronger economy – and I think those differences are likely to be reflected in the policy we implement.

The Fed was already winding down a bond-buying program it used to support the economy, and that program is on track to end in March. Statements from the Fed after the meeting and remarks from Mr. Powell indicated that central bankers could begin to reduce their holdings of government-backed debt soon after they began raising interest rates, a move that further remove support from markets and the economy.

Investors are watching the Fed’s next steps nervously, fearing that its policy changes could hurt prices for stocks and other assets and quickly slow the economy. Wall Street stocks gave up gains and government bond yields rose as Mr Powell spoke. The S&P 500 ended with a 0.2% loss after rising 2.2% earlier. The yield on 10-year Treasury bills, an indicator of investors’ expectations for interest rates, jumped to 1.87%.

The Fed has shifted from boosting growth to preparing for its slowdown as businesses report widespread labor shortages and prices across the economy — for rent, cars and canapes – soar. Consumer prices are rising at the fastest rate since 1982, eating away at paychecks and creating political liability for President Biden and Democrats. It’s the Fed’s job to keep inflation under control and set the stage for a strong labor market.

“The Fed has completed its shift from patience to panic over inflation,” Diane Swonk, chief economist at Grant Thornton, wrote in a research note to clients after the meeting. “His next move will be to raise rates.”

The Fed’s withdrawal of policy support could dampen consumer and business demand as borrowing money to buy a car, boat, house or business becomes more expensive. Slower demand could give supply chains, which have lagged during the pandemic, leeway to catch up. By slowing hiring, the Fed’s actions could also limit wage growth, which could otherwise fuel inflation if employers raise prices to cover higher labor costs.

Investors raised their expectations for rate hikes after the meeting and now expect the Fed to raise rates five times this year, based on market pricesand that the Fed’s key rate ends the year between 1.25 and 1.5%. And economists are increasingly warning that central bankers may act quickly – perhaps by raising borrowing costs with each consecutive meeting instead of leaving gaps, or by raising by half -percentage point instead of the more typical quarter point moves.

But Mr Powell balked when asked about the pace of rate increases, saying it was important to be “humble and nimble” and that “we are going to be driven by the incoming data and the changing outlook”.

“He went out of his way not to go down a predefined path,” said Subadra Rajappa, head of US rates strategy at Societe Generale. The lack of clarity on what will happen next “is a setup for a volatile market.”

While interest rates are expected to rise over the next few years, most economists and investors do not expect them to return to the double-digit levels that prevailed in the early 1980s. that its long-term interest rate could hover around 2.5%.

Investors have also been watching with anticipation how quickly the Fed will reduce its asset balance sheet. The Fed’s policy committee issued a statement of principles for that process on Wednesday, setting out plans to “significantly” reduce its holdings “predictably” and “primarily” by adjusting the amount it reinvests as the assets expire.

“They’re trying, I think, to reduce market uncertainty around the balance sheet — but they’re telling us it’s happening,” said Priya Misra, global head of rates strategy at TD Securities, adding that the statement suggested that the process would begin in a few months.

Mr Powell noted at his press conference that the two areas the Fed is responsible for – fostering price stability and maximizing jobs – had caused the central bank to “slow away steadily” from its aid to the economy. ‘economy.

“There are several million more job vacancies than there are unemployed,” Mr Powell said. “I think there is enough room to raise interest rates without threatening the labor market.”

The unemployment rate has dropped to 3.9%down from its peak of 14.7% at the worst economic time of the pandemic and close to its February 2020 level of 3.5%. Wages are rising at the fastest pace in decades.

At the same time, Powell said, the problems pushing inflation higher have been “bigger and longer lasting” than expected, and he noted the Fed is “risk-attentive” that growth wages could still fuel price gains.

The Fed’s favorite inflation gauge is expected to show prices are up 5.8% in the year to December when the latest report comes out on Friday, more than double the 2% pace the Fed is targeting annually and on average.

Prices are high in part because global supply chains struggle to produce and transport enough lumber, computer chips and clothing to keep pace with growing demand for goods. The pandemic has changed consumption habits, and households have money in their pockets thanks to long months spent at home and repeated government aid.

If the virus subsides, it will help things get back to normal by allowing factories to operate at full speed without gradual shutdowns and allowing consumers to spend their money on trips to the nail salon or Disney World instead of new kitchen tables and bathroom renovations.

Fed officials — and many economists — spent much of 2021 predicting that conditions would stabilize and inflation would die out on its own. This does not happen.

Central bankers continued to believe that the recovery in prices will wane significantly by the end of this year, but they have also guided policy to a position from which it can combat any sustained inflationary pressure. By making it more expensive to buy a lawnmower on credit or a car with a car loan, the Fed’s rate hikes could help calm the US spending spree.

At their December meeting, decision makers planned that they raise interest rates three times This year. They did not release a new set of economic projections with this policy statement. The next quarterly estimates will arrive in March.

“Since the December meeting, I would say the inflation picture is about the same but probably slightly worse,” Powell said when asked about the Fed’s previous expectations.

While presidential administrations generally dislike rate hikes — they slow down the economy — inflation has become a top concern for voters and a thorny political hurdle for Mr. Biden as he tries to push his way through. legislative program. The White House has no say in Fed policy, but he signaled the acceptance recent decisions by the central bank to withdraw economic aid.

“Obviously the Fed is independent,” White House press secretary Jen Psaki said Wednesday after the Fed’s release and press conference. “Chair Powell has indicated his plans for recalibration in the past, and the president expressed support for that last week.”

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