Fed Interest-Rate Decision Tees Up March Increase
Officials have accelerated plans to unwind support for the economy amid rising inflation
The Federal Reserve held short-term interest rates steady on Wednesday and signaled intentions to raise them in mid-March, the latest turn toward removing stimulus to temper elevated inflation.
“It will soon be appropriate to raise the target range for the federal-funds rate,” the Fed said in its postmeeting statement.
At a news conference, Fed Chairman Jerome Powell said the central bank’s rate-setting committee was ready to raise rates at its March 15-16 meeting. “The economy no longer needs sustained monetary policy support,” he said.
The central bank approved one final round of asset purchases, which will bring that stimulus program to a conclusion by March. Officials continued deliberations at their two-day meeting over how and when to shrink the Fed’s $9 trillion securities portfolio, which has more than doubled since March 2020.
The Fed released a separate one-page statement that spelled out high-level principles to guide a process for “significantly reducing” those holdings.
Stocks sold off during Mr. Powell’s press conference on Wednesday afternoon, and yields on 10-year Treasury securities jumped as investors anticipated a more aggressive path of rate rises.
The Fed cut short-term interest rates to near zero and started buying bonds to lower long-term rates in 2020 as the coronavirus pandemic hit the U.S. economy, triggering financial-market volatility and a deep, short recession.
Officials pledged to hold interest rates near zero until inflation was forecast to moderately exceed 2% and until the labor market returned to levels consistent with maximum employment.
Mr. Powell indicated he and his colleagues believe those goals have been met. Both inflation and employment “are calling for us to move steadily away from the very highly accommodative policies we put in place during the challenging economic conditions that the economy faced earlier in the pandemic,” he said.
Brisk demand for goods and shortages for intermediate goods such as semiconductors have pushed inflation to its highest 12-month readings in decades. Inflation rose 5.7% in November from a year earlier, using the Fed’s preferred gauge, and easily surpassed the Fed’s first objective.
But it has been developments in the labor market that provided greater urgency in recent weeks for the Fed to accelerate plans to raise rates much faster than officials anticipated last summer.
Sharp wage gains and a historic drop in the unemployment rate over the second half of last year—to 3.9% in December from 5.9% in June—led officials Wednesday to declare their employment-related goal had also been achieved.
Fed officials face a tricky task of responding to high inflation with two different policy instruments, which could provide more ammunition to slow the economy, but which have in the past caused confusion with markets.
Mr. Powell and his colleagues have indicated they will start the process of shrinking their asset holdings sooner than they did after the central bank stopped buying bonds in 2014. They have also indicated that the process of shrinking those holdings—by allowing securities to mature without reinvesting their proceeds into new ones—is likely to proceed faster than it did the last time the Fed reduced its holdings in 2017.
The Fed said Wednesday that it wants adjustments of its short-term benchmark interest rate, the federal-funds rate, to be the primary way that it responds to changes in the economic outlook. Officials have indicated they would again opt for a path for unwinding their asset holdings that runs on a premapped schedule once they have raised rates. But the statement provided no guidance about when that process might start.
The prospect of more interest-rate increases and a shrinking Fed portfolio to reduce inflation has led to heightened market volatility in recent days, prompting investors to sell shares of some technology companies, cryptocurrencies and other risky assets that enjoyed a boom last year.
The Fed’s turn to tighten policy “is definitely not a sudden revelation and has been more of an evolution, so why the market has just now gotten the message is a little confounding,” said Tom Graff, head of fixed income and portfolio manager at Brown Advisory.
Mr. Graff said markets have taken the Fed’s promises of tighter monetary policy more seriously after officials earlier this month signaled they had begun contemplating plans to shrink their asset portfolio. “If your thesis was that a particular stock valuation made sense because interest rates were always going to remain extremely low, then that was on borrowed time,” he said.
For months last year, Mr. Powell and his colleagues said they didn’t need to raise rates to bring inflation down because they believed high readings stemmed primarily from supply-chain bottlenecks and other difficulties associated with reopening the economy.
Mr. Powell changed course in November and said that the central bank was concerned inflation might become entrenched. That set in motion a policy pivot that has been rapid by Fed standards, given its preference to move in measured steps to avoid whipsawing markets.
The pivot reflected a shifting calculus about the potential for stronger demand to push up prices such as wages and rents that could keep inflation elevated even after bottlenecks and shortages of items such as cars and trucks abate.
Officials are giving more weight to the prospect that the aggressive fiscal- and monetary-policy responses to the pandemic altered traditional recessionary dynamics, buoying wage growth that normally takes longer to recover after a downturn.
A sharp run-up in home values, stocks and other assets has boosted wealth for many Americans, fueling stronger demand and potentially allowing some to retire earlier than they had anticipated, tightening the labor market.
Central-bank officials last month penciled in three quarter-percentage-point interest rate increases this year and three more next year. They based the projections for the increases on a forecast that sees inflation falling below 3% by December and to slightly more than 2% by the end of next year.
Mr. Powell said that, since the Fed’s last meeting, he had become somewhat less confident in his projection of how far inflation would decline this year. “That does raise the risk that high inflation will be more persistent” and that the Fed would have to raise rates more aggressively, he said.
“This outlook is quite uncertain, and we’re going to have to adapt,” he said.
