MANHATTAN (CN) — Hinting at an interest rate hike coming soon, but with no specific timetable in place, the Federal Reserve said it will cease its bond-buying program entirely by March.
The Federal Open Market Committee announced Wednesday that it will keep the federal funds interest rate at near-zero but could soon increase rate. “With inflation well above 2% and a strong labor market, the committee expects it will soon be appropriate to raise the target range for the federal funds rate,” it said,
The committee also noted it would continue “tapering” its bond purchases by $30 billion next month, and cease purchasing such assets altogether by early March, something the Fed already had indicated late last year. It is also unclear, however, when the Fed will begin to unload the $9 trillion already on its balance sheet.
In a statement, Fed Chair Jerome Powell said the central bank would begin reducing its balance sheet only after interest rate increases have begun. He also noted that the economy is “much stronger” now than it was in 2015 when the Fed began raising interest rates following the last economic downturn.
“The economy no longer needs sustained high levels of monetary policy support,” Powell said. The FOMC will meet next from March 15 to 16, during which it will make its decision on whether to raise interest rates. “I think there is quite a bit of room to raise interest rates without threatening the labor market,” Powell told reporters during a virtual press conference. “This is a very, very strong labor market.”
Powell also noted that the Fed’s balance sheet “is substantially larger than it needs to be,” and that the Fed might move “sooner and faster” to taper its purchases than it did after the Great Recession. Before the Fed shrinks its balance sheet, however, he noted that “at least one other discussion” after the central bank’s March meeting will need to happen. That means the Fed won’t start dumping assets until mid-May at the earliest.
In its statement, the committee noted that business sectors hammered during the pandemic have improved, job gains have been solid, and the unemployment rate has dropped, while supply-chain issues continue to cause elevated inflation. “Overall financial conditions remain accommodative, in part reflecting policy measures to support the economy and the flow of credit to U.S. households and businesses,” the committee said.
The central bank also reissued its statement on “longer-run goals and monetary policy strategy,” in which it noted a major goal of achieving “maximum employment” and of 2% inflation. It noted as well that omicron and other new variants of Covid-19 pose a continued threat to the economic recovery.
The news was largely expected, but Powell’s comments did not steady an already volatile Wall Street. The Dow Jones Industrial Average, which briefly was up more than 500 points, dropped sharply right after the Fed’s announcement and ended the day down 130 points. The S&P 500 and Nasdaq also declined following Powell’s press conference but ended up relatively flat for the day.
The news was largely expected. “Whether three or four hikes this year, we do not expect a classic, lengthy tightening cycle,” said John Lynch, chief investment officer at Comerica Wealth Management. “The equity markets may also play a role in determining the extent of the Fed’s hiking campaign.”
Others were less pleased with the Fed’s approach. “Message from Powell: ‘We’re winging it. Wish us luck,’” wrote Peter Boockvar, chief investment officer at Bleakley Advisory Group, who has been a frequent critic of the Fed’s accommodative stance during the pandemic.
The Fed has kept its interest rates near 0% since mid-March 2020, when Covid-related lockdowns caused the economy to tank. Before the virus took hold of the economy, or even headlines, the federal funds rate hovered around 1.5%.
The central bank also has about $9 trillion on its balance sheet, mostly in the form of treasuries and mortgage-backed securities that it had purchased to help ease markets during the coronavirus crisis. The Fed has begun the process of reducing the rate at which it purchases those bonds, a process known as tapering.
While the Fed throughout the years has tinkered with those two methods — the main monetary arrows in its quiver — it has rarely employed both at the same time. The last time the Fed did so was in 2018, which caused the S&P 500 to plummet 20% in three months.
In the early days of the Covid-19 pandemic, the Federal Reserve was a beacon for investors, using its balance sheet to offer a lending program to mid-sized companies, keeping interest rates low to improve market liquidity, and buying various bonds at a time when equities were seen as risky.
In the summer of 2020, Powell then announced it would be dumping the Taylor Rule, an economic model that dictates when the Fed should raise interest rates based on whether inflation is rising or how gross domestic product growth matches with expectations.
During that year’s annual Jackson Hole Symposium, Powell said at the time that it wanted inflation to increase to allow the economy to weather the Covid storm. The Fed’s new approach, he said, would be to allow inflation to rise to 2% on average over an unspecified period, and only then to raise interest rates.
“The persistent undershoot of inflation from our 2% longer-run objective is a cause for concern,” Powell said during the symposium, hinting then that he worried about deflation, noting that “inflation that is persistently too low can pose serious risks to the economy."
While many experts followed the Fed’s advice that inflation would be transitory, many now worry that Powell and company have waited too long to deal with the problem and that price increases are now entrenched in the economy.
Consumer prices have increased nearly 7% over the last year and inflation is at the highest rate since 1982. Powell has since changed course from calling inflation “transitory” to saying it was “elevated.” In December, the central bank announced it would move more aggressively on raising interest rates and tapering bond purchases.
Prior to Wednesday’s announcement, most analysts had expected Powell to take a relatively dovish approach to the press conference, especially given the recent turbulence in the markets. In an investor’s note, analysts at JP Morgan Chase noted early Wednesday that the central bank was “likely to strike a more dovish tone relative to extreme investor expectations, which could trigger an equity rebound.”
They added: “With high frequency economic data slowing the last two to four weeks, fiscal impulse turning negative, and weakening [first quarter] GDP, it could give the Federal Open Market Committee some reason for caution.”
Analysts at ING, led by chief international economist James Knightley, said a 50 basis-point increase was “far fetched” given the heightened concerns about Covid due to the omicron variant. They expect the Fed to focus most of its efforts on shrinking its sizable balance sheet, citing Christopher Waller, a member of the Fed’s Board of Governors, who suggested last month that the balance sheet could be reduced from 36% of GDP to 20%.
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