The Federal Reserve on Wednesday significantly raised its inflation expectations for this year and brought forward the timeframe for the next rate hike.
However, the central bank gave no indication of when it will cut its aggressive bond-buying program, though Fed chair Jerome Powell admitted that officials discussed the issue at the meeting.
“You can think of this meeting we had as the ‘talking about talking about’ meeting,” Powell said in a sentence reminiscent of a statement he made a year ago that the Fed “doesn’t thinking about thinking about a rate hike ”.
As expected, the Federal Reserve’s Monetary Open Market Committee unanimously left the benchmark interest rate for short-term loans close to zero. However, officials said rate hikes could happen as early as 2023 after saying in March that there would be no hikes until at least 2024. The so-called scatter plot of individual member expectations indicated two increases in 2023.
Although the Fed raised its headline inflation forecast to 3.4%, a full percentage point above the March projection, the post-meeting statement continued to say that inflationary pressures were “temporary”. The increased expectations come amid the largest rise in consumer prices in about 13 years.
“The market didn’t expect that,” said James McCann, deputy chief economist at Aberdeen Standard Investments. “The Fed is now signaling that rates need to rise sooner and faster, with a forecast for two rate hikes in 2023. This change in stance is somewhat at odds with recent claims by the Fed that the recent rise in inflation is temporary.”
Markets reacted to the Fed news with equity declines and higher government bond yields as investors anticipated more restrictive Fed policies ahead, including the likelihood that bond purchases would ease earlier this year.
“If you want to get two rate hikes in 2023, you’ll need to start tapering pretty soon to get there,” said Kathy Jones, Head of Fixed Income at Charles Schwab. “It takes maybe 10 months to a year to go down at a moderate pace. Then we may have to start cutting later this year and if the economy continues to run a little hot then rate hikes should come sooner rather than later. “
Despite the raised forecast for this year, the Committee still sees inflation in the long term towards its target of 2%.
“Our expectation is that this high inflation data will now wear off,” Powell said at his press conference after the meeting.
Powell also cautioned against reading too much into the dot plot, saying it was “not a good predictor of future interest rate movements. “The increase is far in the future,” he said.
Powell noted that some of the dynamics associated with the reopening “increase the possibility that inflation could be higher and more persistent than we expect”.
Powell said that progress toward the Fed’s dual employment and inflation targets was slightly faster than expected. In particular, he pointed to the strong growth recovery that the Fed will achieve in 2021 with GDP of 7%.
“Much of this rapid growth reflects the continued recovery in activity from low levels, and the factors more affected by the pandemic remain weak but have improved,” he said.
Officials raised their GDP expectations for this year from 6.5% to 7%. The unemployment estimate remained unchanged at 4.5%.
The statement softened some of the language of previous statements since the Covid-19 crisis. As of last year, the FOMC had said that the pandemic was “causing tremendous human and economic hardship in the United States and around the world.”
Instead, Wednesday’s statement noted progress in vaccination against the disease and stated that “indicators of economic activity and employment have strengthened. The sectors hardest hit by the pandemic remain weak but have improved. “
Investors watched the meeting closely for statements on how Fed officials view an economy that has expanded rapidly since the depths of the 2020 pandemic crisis.
Recent indicators show that in some ways the US has been expanding the fastest since World War II. But that growth has also been accompanied by inflation, and the central bank has been pressured from various quarters to at least start cutting back on the monthly bond purchases of at least $ 120 billion it makes.
At his post-meeting press conference, Fed chairman Jerome Powell noted that Fed officials have “discussed” progress on inflation and employment targets for asset purchases and will continue to do so in the months ahead .
Markets had been looking for a way for the committee to look into its open market operations, where it provides short-term funding to financial institutions. The so-called overnight repos, where banks swap high-quality collateral for reserves, have seen record demand recently as institutions look for returns above the negative interest rates they see in some markets.
The committee increased the interest it pays on excess reserves by 5 basis points to 0.15%.
On a separate matter, the FOMC announced that it would extend dollar swap lines with global central banks until the end of the year. The currency program is one of the last remaining initiatives by the Fed from the Covid era to keep global markets flowing.
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