Fed Officials Project Three Interest Rate Rises in 2022 and Accelerate Stimulus Wind-Down
Reducing bond-buying program more quickly opens door to earlier interest rate rise
Appeared in The Wall Street Journal
December 16, 2021
By Nick Timiraos
The Federal Reserve set the stage for a series of interest rate increases beginning next spring, completing a major policy pivot that showed much greater concern about the potential for inflation to stay high.
Most central bank officials, in projections released Wednesday at the conclusion of their two-day meeting, penciled in at least three quarter-percentage-point rate increases next year. In September, around half of those officials thought rate increases wouldn't be warranted until 2023.
For months, Fed leaders had stuck to a view that higher price pressures this year were caused primarily by supply-chain bottlenecks and would ease on their own. But Fed Chairman Jerome Powell had in recent weeks signaled much less conviction about that forecast, and the projections Wednesday suggest most of his colleagues share his concern.
Stocks closed higher as investors welcomed the Fed's messages. The S&P 500 rose 1.63%, reversing earlier declines and ending the day near a record. The Dow Jones Industrial Average added 383.25 points, or 1.08%. The Nasdaq Composite Index surged 2.15%. Treasury yields rose as well.
One immediate sign of officials' increased urgency: They approved plans that will more quickly scale back their Covid-19 pandemic stimulus efforts, ending a program of asset purchases by March instead of June. That opens the door for them to start raising rates at their second scheduled meeting next year, in mid-March.
The Fed wants to end the asset purchases, a form of economic stimulus, before it lifts its short-term benchmark rate from zero to prevent inflation from staying too high.
"A decision to taper faster says something about your desire to raise rates," said Michael Gapen, chief U.S. economist at Barclays, who expects the Fed will lift them in March. "There is no reason to taper faster unless you want to get to rate hikes sooner. That's the only reason you'd want to do it."
The shift is the latest sign of how an acceleration and broadening of inflationary pressures, together with signs of an ever-tighter labor market, have reshaped officials' economic outlook and policy planning.
"There's a real risk now, I believe, that inflation may be more persistent and... the risk of higher inflation becoming entrenched has increased," said Mr. Powell at a news conference Wednesday afternoon. "That's part of the reason behind our move today, is to put ourselves in a position to be able to deal with that risk."
Fed officials in early November agreed to reduce their then-$120 billion-a-month in bond purchases by $15 billion a month, to $90 billion this month. On Wednesday, officials said they would accelerate that wind-down beginning next month, reducing purchases by $30 billion a month. As a result, they will purchase $60 billion in Treasury and mortgage securities in January, putting the program on track to end by March.
"If they could wave a wand, I think they would want to stop it altogether, because it's not needed in the economy at this point. There's so much money flowing through every single asset class," said Kenneth Rosen, housing economist at the University of California, Berkeley.
Officials in their postmeeting statement described their goal of inflation moderately exceeding their 2% target as being met, one of two key criteria the central bank has laid out to justify raising rates. Officials said they hadn't yet met the other criterion, in which labor market conditions are consistent with maximum employment.
But Mr. Powell suggested that goal might be achieved soon. "We're making rapid progress toward maximum employment," he said.
For the first time since the Fed slashed rates to near zero when the pandemic hit the U.S. in March 2020, Mr. Powell said nothing to dispel expectations that officials could be contemplating rate rises in the next few months.
"We'll be in a position to raise interest rates as and when we think it's appropriate," he said. "And we will, to the extent that's appropriate."
Brisk demand for goods, disrupted supply chains, temporary shortages and a rebound in travel have pushed 12-month inflation to its highest readings in decades. Core consumer prices, which exclude volatile food and energy categories, were up 4.1% in October from a year earlier, according to the Fed's preferred gauge.
In economic projections released Wednesday, most Fed officials project core inflation to reach 4.4% at the end of this year before declining to 2.7% next year and 2.1% by the end of 2024. That is up from projections in September that inflation would slow from 3.7% to 2.3% at the end of next year.
Fed officials' decision to take their foot off the gas more quickly reflects a shifting calculus about the potential for stronger demand to push up prices - such as wages and rents - even after supply-chain bottlenecks and shortages of items such as cars abate.
"It isn't so much inflation today that's the problem. What they want to make sure is that they haven't let the situation get out of hand, where once the supply-based inflation has come down, demand-based inflation tells them they should have gone sooner or faster," said Laurence Meyer, a former Fed governor who is now president of research-advisory firm Monetary Policy Analytics.
Retail sales rose modestly last month, as holiday shoppers grappled with rising prices and supply shortages, which had prompted some to snap up gifts earlier. Sales at U.S. retail stores, online sellers and restaurants rose by a seasonally adjusted 0.3% in November from the previous month, a slowdown from October's robust 1.8% increase, the Commerce Department said Wednesday.
Wednesday's rate projections show all 18 Fed officials expect rates will need to rise next year. After projecting three quarter-percentage-point rate rises next year, most officials penciled in at least three more rate increases in 2023 and two more in 2024.
Beginning in April, officials characterized elevated inflation as "transitory," largely because it reflected supply-chain bottlenecks that officials expect will abate. But they stopped using that term in their policy statement Wednesday, partly due to confusion over what the word means and to reflect greater uncertainty over how long it could take inflation to slow.
Mr. Powell said he had been surprised in recent months by a run of hotter economic data that hints at stronger demand in the U.S. economy and not simply idiosyncratic supply constraints that have also pushed up prices. A sharp run-up in home values, stocks and other assets has boosted wealth for many Americans, fueling stronger demand and potentially allowing some to retire earlier than they had anticipated, tightening the labor market.
Questions remain over the tightness in the job market, especially because it is hard to tell how many people might have left the workforce for good. Over the three months ending in November, the unemployment rate has fallen by 1 percentage point, to 4.2%.
While there are still 3.9 million fewer people working than in February 2020, some of that gap might reflect retirees or others who are choosing not to work for several reasons, including fear of Covid-19, increased household wealth or lack of child care.
"We're not going back to the same economy we had in February of 2020, and I think early on, the sense was that that's where we were headed," Mr. Powell said.
Fed officials are facing two opposite risks. One is that they tighten monetary policy that causes the economy to slow on top of a sharp drop in the rate of inflation next year. The other is that inflation stays higher and households and businesses come to expect prices to keep rising, leading to a wage-price spiral.
"That gets really hard to deal with," said William English, a former senior Fed economist who is now professor at the Yale School of Management. "They're just in a very tough situation where there are bad risks in both directions, and they're trying to balance those risks."
Officials are giving more weight to the prospect that the aggressive fiscal- and monetary-policy responses to the pandemic last year altered traditional recessionary dynamics, buoying hiring and wage growth that normally takes longer to recover after a downturn.
When the pandemic hit, it "looked at the beginning like it might cause a global depression, and so we threw a lot of support at it," Mr. Powell said. "What's coming out now is really strong growth, really strong demand, high incomes... People will judge in 25 years whether we overdid it or not, but we are where we are."
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