Faced with turbulent markets and rising inflation, Wednesday’s Federal Reserve indicated that it may soon increase interest rates as part of its wider tightening historically loose monetary policy.
It was not surprising that the Fed’s policymaking panel said it expected a quarter percentage point rise in its benchmark short term borrowing rate. This would mean that it would be first rise since December 2018.
Jerome Powell, chairman of the Fed said that they could pursue an aggressive course.
Powell stated at his news conference after the meeting that he believes there is a lot of room for raising interest rates while not threatening to disrupt the labor market. The following morning, Powell said that he felt more upbeat than usual. major stock market averages turned negativeSoon after Powell’s announcement.
This was in response to rising inflation, which is now at the highest level it has been in almost 40 years. Although the Fed’s move towards less accommodating policy was well-telegraphed in the last few weeks, the markets have become incredibly choppy recently as investors worry that they might be more restrictive than anticipated.
It post-meeting statementAlthough the Federal Open Market Committee has not provided a date for when it will happen, there is evidence that it may occur as early as March. The statement was unanimously adopted.
The statement stated that “with inflation at a high of 2 percent, and strong labor markets, it is likely that the Committee will soon consider raising the Federal Funds Rate target range.” The Fed has not met in February.
The committee also noted that the monthly central bank bond-buying program will be at $30 billion in February. This indicates that the program could end in March, at the same rate that interest rates rise.
Wednesday was not a day when there were any indications the Fed would begin to lower its bond holdings. its balance sheetNearly $9 Trillion
The committee however released a statement outlining“Principles to reduce the size of our balance sheets.” This statement begins with the assertion that the Fed plans to “significantly reduce” asset holdings.
The policy document stated that the benchmark funds rates are the primary means to adjust the stance on monetary policy. Further, the committee noted that balance sheet cuts would occur after rates rises begin and it would be done “in a predictable fashion” by changing how much bank proceeds from bond holdings will be reinvested or allowed to be rolled off.
Michael Pearce of Capital Economics, senior U.S. economist noted that “The Fed’s decision to’soon become appropriate’ in raising interest rates is an indication that a March rate increase is on the horizon.” “The Fed’s plan to reduce its balance sheets once interest rates increase suggests that an announcement about this could come at the same time as the next meeting. We were expecting something a little more hawkish.
The Fed’s announcement was eagerly anticipated by the markets.
Investors expected the Fed would raise the rate, but they are actually pricing more aggressively than the FOMC official indicated in December’s outlook. According to CME’s FedWatch tool, which calculates probabilities using the fed funds futures markets, three of the Fed’s 25-basis point rate moves were made at that time. The market, however, is pricing in four increases.
Traders expect a funds rate of around 1% by the end, which is a significant increase from its current near-zero level.
Fed officials are now concerned about the persistence of inflation after months of insisting price rises were temporary. The fastest pace of inflation in 12 months since 1982 is 7% consumer prices.
Officials have had to reconsider a strategy which has resulted in the most flexible monetary policy ever implemented by Fed officials. In the beginning of the new Fed, the central bank cut its benchmark rate from 0% to 0.255%. Covid pandemicEach month, he has bought billions in Treasurys as well as mortgage-backed securities.
Powell stated that the Fed will shift from a very high-accommodative policy towards a substantially lower accommodative and, over time, to a more accommodative one.
Quantitative easing is sometimes known as bond-buying. It has helped bring the Fed’s assets to its balance sheet close to $9 trillion. Powell indicated that after a couple of months, the Fed may allow some of its bond proceeds to run off every month before it reinvests the remainder. The Fed currently reinvests every penny of these proceeds.
Powell claimed that “the balance sheet is significantly larger than what it should be.” There is a lot of shrinkage that needs to happen in the balance sheet. It will be a long process. That process should be predictable and orderly.
Goldman Sachs stated a few days back that the reduction in the balance sheet will begin in June at $100 billion per month. This pace is roughly double what was achieved with the runoff move a couple of years ago.