Fed accelerates taper of bond purchases, eyes three interest-rate hikes in 2022

Fed accelerates taper of bond purchases, eyes three interest-rate hikes in 2022

The Federal Reserve on Wednesday said it will phase out its bond-buying stimulus program by March — much faster than previously planned — and signaled it would raise interest rates more aggressively to combat high U.S. inflation.

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The more assertive approach comes after upward pressure on prices pushed retail inflation to the highest level in several decades. The Fed acknowledged the surprising and sustained increase in prices by banishing the word “transitory” to describe inflation from its policy statement.

In its new wording, the Fed said inflation was elevated. Prices rose at a 5% yearly rate as of October, using the central bank’s preferred PCE price gauge.

“This is a major pivot from the Fed, prompted by clearer evidence that inflation is broadening,” said Brian Coulton, chief economist of Fitch Ratings.

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Aside from worries about inflation, Fed Chairman Jerome Powell said the economy has made enough progress to justify removing stimulus that the central bank put in place early in the pandemic to prevent a major depression.

The U.S. has recovered rapidly, and the labor market is moving toward full employment, Powell said in a press conference after the Fed’s two-day strategy meeting.  

New projections based on the median forecast by Fed officials see the federal funds rate rising to 0.9% by the end of 2022, to 1.6% by the end of 2023 and to 2.1% by the end of 2024.

That implies three quarter-percentage-point interest-rate increases next year, followed by three in 2023 and two in 2024.

The pace of rate increases projected by officials is somewhat faster than what they foresaw in September, when the Fed saw only one rate hike next year and its benchmark rate rising to 1.8% by 2024.

The Fed sees 2.5% as the “neutral” level of interest rates, neither pushing on the accelerator or applying the brakes of the U.S. economy. 

U.S. stocks
DJIA,
+1.08%

SPX,
+1.63%

moved higher after the Fed’s decision. Some analysts said the low level of projected interest rates by 2024 contributed to the market’s bullishness.

Some former Fed officials think the central bank will have to become more aggressive to tame inflation. On the other hand, many in the markets think the Fed won’t be able to raise policy rates anywhere close to 2.5%.

The Fed altered its guidance somewhat to take account of higher inflation — removing language that the monetary-policy-setting Federal Open Market Committee expects to maintain an accommodative stance until the goals of maximum employment and inflation of 2% over time are achieved.

Powell said the Fed had only preliminary discussions on when it will allow its massive balance sheet to shrink. That policy is known as “quantitative tightening.”

“We did have a first discussion of balance sheet issues [but] didn’t make any decisions,” Powell said.

Diane Swonk, chief economist at Grant Thornton, said any reduction in the balance sheet could amplify the tightening effects of rate hikes. “Powell is walking a tightrope here, wanting to dampen inflation but not derail the recovery,” Swonk said.

Former Fed officials continue to worry publicly that the Fed might be behind the curve in its effort to curb inflation.

Former Fed governor Rick Mishkin told CNBC that the Fed has let inflation escape and the central bank could have to slam on the brakes to slow it down. That would have ripple effects through the domestic economy and around the world.

Mickey Levy, chief economist at Berenberg Capital, predicted that the Fed will eventually have to raise rates well above the “dots” plotted in December.

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“The risk of higher inflation has certainly increased,” Powell said. ” And I think part of the reason behind our move[s] today is to put ourselves in a position to be able to deal with that risk,” Powell said.

The yield on the 10-year Treasury note
TMUBMUSD10Y,
1.460%

rose after the Wednesday announcement but remains well off its highs for the year. Some analysts say that is a signal the market doesn’t think the Fed will be able to follow through with its rate hikes, but Powell said overseas investors are snapping up longer-dated U.S. bonds and keeping rates low.

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