MNI: Fed Nods To March Rate Hike, Signals QT Is Forthcoming

The Federal Reserve signaled Wednesday it will likely begin raising interest rates at its next meeting in March to counter elevated inflation pressures that have caught policymakers flat-footed, and laid out a basic contour of plans to start shrinking its USD8.7 trillion balance sheet.

“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,” the FOMC said. The Fed also said in a separate statement that the committee thought it “appropriate at this time to provide information regarding its planned approach for significantly reducing” the balance sheet.

The FOMC said it still views changes in the fed funds rate as the primary tool of monetary policy. In addition, the Fed indicated balance sheet reduction “will commence after the process of increasing the target range for the federal funds rate has begun.”

The Fed maintained its target for the federal funds rate in a zero to 0.25% range. A March hike would be the first since 2018. The Fed will end its current QE program in early March as expected.

U.S. inflation has taken policymakers and most economists by surprise, surging 7% in the year to December according to the consumer price index and to 5.7% in the year to November as measured by the Fed’s preferred PCE index.

NOT SO TRANSITORY

This forced an abrupt shift from policymakers from a highly dovish stance premised on transitory inflation toward warnings about the risk that price pressures will become more persistent due to lingering supply chain bottlenecks and strong consumer demand.

The labor market has also improved much more rapidly than forecast, with the jobless rate falling to 3.9% in December and many other measures of tightness including job openings and quits hitting records.

In its December Summary of Economic Projections, the Fed suggested it planned on raising interest rates at least three times this year. Officials also saw PCE inflation coming down to 2.6% by the end of the year, an estimate many economists see as overly optimistic. The next SEP will be released in March and many analysts are looking for another hawkish turn in the expected path of rates.