Facing both turbulent financial markets and raging inflation, the Federal Reserve on Wednesday indicated it could soon raise interest rates for the first time in more than three years.
In a move that came as little surprise, the Fed’s policymaking group said a quarter-percentage point increase to its benchmark short-term borrowing rate is likely forthcoming. It would be the first increase since December 2018.
The statement comes in response to inflation running at its hottest level in nearly 40 years. Though the move toward less accommodative policy has been well-telegraphed over the past several weeks, markets in recent days have been remarkably choppy as investors worried that the Fed might tighten policy even more than expected.
The post-meeting statement from the Federal Open Market Committee did not provide a specific time for when the increase will come, though indications are that it could happen as soon as the March meeting. The statement was adopted without dissent.
“With inflation well above 2 percent and a strong labor market, the Committee expects it will soon be
appropriate to raise the target range for the federal funds rate,” the statement said. The Fed does not meet in February.
In addition, the committee noted the central bank’s monthly bond-buying will proceed at just $30 billion in February, indicating that program could end in March as well at the same time that rates increase.
There were no specific indications Wednesday when the Fed might start to reduce bond holdings that have bloated its balance sheet to nearly $9 trillion.
However, the committee released a statement outlining “principles for reducing the size of the balance sheet.”
That policy sheet noted that the benchmark funds rate is “primary means of adjusting the stance of monetary policy.” The committee further noted that the balance sheet reduction would happen after rate hikes start and would be “in a predictable manner” by adjusting how much of the bank’s proceeds from its bond holdings would be reinvested and how much would be allowed to roll off.
“The Committee is prepared to adjust any of the details of its approach to reducing the size of the balance sheet in light of economic and financial developments,” the document said.
Markets had been anxiously awaiting the Fed’s decision. Stocks added to gains afterwards while government bond yields were mostly higher, though only slightly.
Markets had been expecting the Fed to tee up the first of multiple rate hikes, and in fact are pricing in a more aggressive schedule this year than FOMC officials indicated in their December outlook. At that time, the committee penciled in three 25 basis point moves this year, while the market is pricing in four hikes, according to the CME’s FedWatch tool that computes the probabilities through the fed funds futures market.
Traders are anticipating a funds rate by the end of the year of about 1%, from the near-zero range where it’s currently pegged.
Fed officials have been expressing concern lately about persistent inflation, following months of insisting that the price increases were “transitory.” Consumer prices are up 7% from a year ago, the fastest 12-month pace since the summer of 1982.
The durability of inflation has caused officials to rethink a strategy that has produced the easiest monetary policy in Fed history. The central bank slashed its benchmark rate to a target of 0%-0.25% in the early days of the Covid pandemic and has been buying billions of dollars in Treasurys and mortgage-backed securities each month.
That program, sometimes called quantitative easing, has brought the Fed’s total assets on its balance sheet to nearly $9 trillion. Market participants expect the Fed will wait a few months then start allowing some of the proceeds from its bond holdings to run off each month while reinvesting the rest. As things stand now, the Fed reinvests all of those proceeds.
Markets were awaiting Fed Chairman Jerome Powell’s post-meeting news conference for more clues about when the reduction in bond holdings might begin. Goldman Sachs said a few days ago that it expects balance sheet reduction to start in June at a pace of $100 billion a month, about double the pace of the previous move of a runoff several years ago.