Fed foresees possible rate hikes
It’s a sign of adequate recovery from recession
WASHINGTON – The Federal Reserve signaled Wednesday that it may start raising its benchmark interest rate next year, earlier than it envisioned three months ago and a sign that it’s concerned that high inflation pressures may persist.
In a statement, the Fed also said it will likely begin slowing the pace of its monthly bond purchases “soon” if the economy keeps improving. The bond purchases have been intended to lower longer-term loan rates to encourage borrowing and spending.
Taken together, the Fed’s plans reflect its belief that the economy has recovered sufficiently from the pandemic recession for it to soon begin dialing back the extraordinary support it provided after the coronavirus paralyzed the economy 18 months ago. As the economy has steadily strengthened, inflation has also accelerated to a threedecade high, heightening the pressure on the Fed to pull back.
Stock and bond traders appeared pleased by the Fed’s policy statement Wednesday, at least initially. Soon after it was issued, the Dow Jones Industrial Average’s gain for the day surged from 1% to 1.5%. And the yield on the 10-year
Treasury note dipped from 1.32% to 1.30%.
The economy has recovered faster than many economists had expected, though growth has slowed recently as COVID-19 cases have spiked and labor and supply shortages have hampered manufacturing, construction and some other sectors. The U.S. economy has returned to its pre-pandemic size, and the unemployment rate has tumbled from 14.8%, soon after the pandemic struck, to 5.2%.
At the same time, inflation has surged as resurgent consumer spending and disrupted supply chains have combined to create shortages of semiconductors, cars, furniture and electronics. Consumer prices, according to the Fed’s preferred measure, rose 3.6% in July from a year ago – the sharpest such increase since 1991.
In its updated quarterly projections, Fed officials now expect to raise their key short term rate once in 2022, three times in 2023 – one more than they had projected in June – and three times in 2024. That benchmark rate, which influences many consumer and business loans, has been pinned near zero since March 2020, when the pandemic erupted.
Before it starts raising rates, though, the Fed expects to begin paring, or tapering, its monthly bond buying. The central bank had signaled last year that it would likely start tapering its $120 billion-a-month in purchases of Treasurys and mortgage bonds once the economy had made “substantial further progress” toward the Fed’s goals of maximum employment and 2% average annual inflation.
“If progress continues broadly as expected, the Committee judges that a moderation in the pace of asset purchases may soon be warranted,” the Fed said in a statement issued after its twoday meeting ended Wednesday.
Taken together, the Fed’s pullback in bond purchases and its eventual rate hikes, whenever they happen, will mean that some borrowers will have to pay more for mortgages, credit cards and business loans.
Most economists expect the central bank to formally announce at its next meeting in November that it will start reducing its bond buying in December. The Fed hasn’t hinted at how fast it will taper the purchases. But it is widely expected to pare its purchases of Treasurys by $10 billion a month and mortgage-backed securities by $5 billion.
The tricky task for the Fed is to explain how it will soon begin withdrawing its economic support while still reassuring investors, consumers and business leaders that it won’t move so fast as to derail the recovery from the recession. Powell has repeatedly expressed his belief that the current high level of inflation will fade as the economy normalizes – and in part for that reason, has said the central bank isn’t yet close to raising interest rates.
But the changes in the Fed’s interest rate projections suggest that the central bank is moving gradually closer to doing so. In March, the 18 officials who make up its policymaking committee predicted that they wouldn’t raise rates at all until after 2023. In June, the committee revised its forecast to two rate hikes in 2023. And now it sees a rate hike as soon as next year.
In its latest forecasts, the policymakers also indicate that they expect the economy to grow more slowly this year, at 5.9%, down from its June projection of 7%. It sees inflation at 4.2% by the end of this year, but raised its projection for inflation next year to just 2.2%, from 2.1%.
Fed Chairman Jerome Powell is also grappling with a major ethics issue surrounding the investments and trading of some Fed regional bank presidents. Robert Kaplan, president of the Federal Reserve Bank of Dallas, revealed in financial disclosures that he traded millions of dollars’ worth of such individual stocks as Amazon, Chevron, Facebook and Google in 2020, while the Fed was taking extraordinary measures to boost the economy.
Eric Rosengren, president of the Boston Fed, invested last year in real estate investment trusts that held mortgagebacked bonds of the type the Fed is buying as part of its efforts to lower borrowing rates. And Powell himself owns municipal bonds, which the Fed bought last year for the first time to shore up that market.
A spokesman said last week that the Fed is taking “a fresh and comprehensive look” at its rules surrounding its officials’ financial holdings. The investments were permitted under the Fed’s current rules, and Rosengren and Kaplan have pledged to sell their holdings and reinvest the proceeds into index funds and cash.
The Fed’s expected policy changes follow similar steps by other central banks in the developed world as growth and inflation have picked up in many countries. The European Central Bank said earlier this month that it would reduce its bond purchases, though it has yet to say that it will fully end them. The central banks of Canada and Australia have also scaled back bond purchases.