Fed Eyes Rate Hikes, Hurries Pace to End Bond-Buying

Inflation-wary central bank sees March halt to ‘taper,’ maybe three rate hikes

Federal Reserve Chairman Jerome Powell
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Alex Wong / Getty Images

U.S. consumers can expect multiple increases in benchmark interest rates next year after the Federal Reserve announced Wednesday it would pull away from its easy-money policies faster than originally planned to help fight inflation.

Key Takeaways

  • The Federal Reserve hastened its pace of removing stimulus to the economy to set the stage for interest rate hikes next year to combat inflation.
  • With prices rising at the fastest pace in 40 years, most members of the Federal Open Market Committee now expect three rate hikes next year.
  • With inflation already above the Fed’s target, the central bank’s other mandate of achieving maximum employment will determine the trajectory of rate hikes.
  • The Fed said the labor market is fast-approaching maximum employment, but risks remain—including from COVID-19 variants. 

The Federal Open Market Committee will wind down its $120 billion per month bond-purchasing program by $30 billion each month—doubling the pace it outlined at its last meeting in November—because of inflation and improvement in the labor market.  

“There’s a real risk now, I believe, that inflation may be more persistent and that may be putting inflation expectations under pressure, and the risk of higher inflation becoming entrenched has increased,” Fed Chairman Jerome Powell said at a news conference following the committee’s December meeting. “I don’t think it’s high at this moment but I think it’s increased. Part of the reason behind our move today was to put us in a position to deal with that risk.”

The Fed had begun buying bonds at the pandemic’s outset to keep long-term rates low and ensure money continued flowing through the economy. With its quicker pace of “tapering,” the central bank is now expected to end the program by March instead of by mid-year, and to start raising its benchmark fed funds rate after that. 

All 18 members of the Fed committee now expect to start raising rates in 2022—compared to only half who expected that at its meeting in September. In a further sign of how hot the Fed sees inflation, 10 members now expect three rate hikes next year, compared to no members expecting three in September. The committee’s median expectation for the fed funds rate next year is 0.9%, up from the 0.3% median the members forecast in September.

The fed funds rate, which had been slashed to between 0% and 0.25% to encourage borrowing when the pandemic hit last year, influences interest rates for a range of consumer loans, from autos and home mortgages to credit cards. Higher rates are meant to cool demand and tamp down inflation in an overheated economy. 

With consumer prices rising in November by 6.8% from a year earlier—the fastest pace since 1982—raising rates and cutting off support for an already-expanding economy have taken on more urgency. The Fed had let inflation run above its average 2% target most of this year, attributing most of the price pressures to pandemic-related issues as it waited for the labor market to strengthen. But now, with inflationary pressures spreading through the economy at alarming rates and hitting consumers hard, Powell has shifted his focus to fighting rising prices.

The Fed also raised its median projection for 2021 consumer inflation to 5.3%, from 4.2% in September. The so-called core rate excluding volatile food and energy prices is now seen at 4.4%, up from 3.7%. The Fed expects headline inflation to ease next year to 2.6%, with core at 2.7%, and to continue ratcheting down slowly through 2024 but remaining slightly above the 2% average target. In an effort to keep inflation down, the committee also penciled in more rate hikes in 2023 and 2024.

Improving Labor Market

But the rate hike trajectory could depend on the employment picture, which Powell said in November is the next test to determine the timing of rate increases. The Fed has a dual mandate to promote price stability as well as maximum employment.

“Amid improving labor market conditions, and very strong demand for workers, the economy has been making rapid progress towards maximum employment,” he said. The Fed’s median forecast for the unemployment rate—4.3% this year, falling to 3.5% in 2022—should allow for rate increases, analysts said.

Still, the Fed left itself some wiggle room, warning that “risks to the economic outlook remain, including from new variants of the virus.”

In a commentary, Michael Gregory, deputy chief economist at BMO Economics, said that means that “the vagaries of the Delta and Omicron variants, how consumer confidence and outlays could react to a winter infection wave, and whether any restrictions occur all point to significant downside economic risks in the weeks and months ahead. Rates hikes are being teed up because of inflation, but the pandemic could still have a say on whether the Fed swings the tightening club in March, May or June.”

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