The Fed is doubling its pace and predicting higher interest rates in 2022

  • The Fed said Wednesday it will double the pace of shrinking its emergency purchases.
  • “Inflation and the further improvement in the labor market” triggered the movement, the Fed said.
  • Fed officials signaled that they will raise interest rates three times in 2022 to cool inflation.

Sky-high inflation has forced the hand of the Federal Reserve.

The central bank announced on Wednesday that it will double the pace at which it is shrinking its emergency asset purchases by downsizing its Treasury purchases by $ 20 billion each month, while its purchases of mortgage-backed securities will shrink by $ 10 billion a month. In a Wednesday statement, it attributed this acceleration to “inflation and further improvement in the labor market.”

As of January, the Treasury Department’s purchases will amount to at least $ 40 billion, while MBS purchases will reach at least $ 20 billion. That is a drop from the pandemic highs of $ 80 billion and $ 40 billion, respectively.

“With rising inflationary pressures and a rapidly strengthening labor market, the economy no longer needs increasing amounts of political support,” Fed Chairman Jerome Powell said at a Wednesday news conference.

The move marks a major shift as the Fed appears to be balancing its goals of curbing inflation while keeping the employment recovery alive. The downsizing of its asset purchases is its first step towards normalizing the unprecedented support it rolled out during the pandemic. The new pace suggests that the Fed’s acquisition of assets will end entirely in March instead of later in 2022.

Faster downsizing paves the way for higher interest rates in 2022. The Fed’s benchmark rate affects borrowing costs across the country from mortgage rates to car loans. The central bank lowered interest rates to record lows in March 2020 to support the economy against the pandemic


recession

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Now that inflation is running at historically high levels, Wednesday’s statement suggests that officials are reversing their ultra-accommodative stance faster than previously expected. Data released on Friday showed year-on-year inflation, which hit 6.8% in November, the highest level since 1982. Although Powell has maintained that the rise will be temporary, a faster slowdown suggests the Fed will fight inflation more aggressively in 2022.

“The Fed has apparently just woken up to the inflationary pressures consuming the US economy,” said Seema Shah, chief strategist at Principal Global Investors. “Price pressure may well ease next year, but inflation will settle at an uncomfortably high level for the Fed – this is a temporary plus.”

Economic projections published by the Fed on Wednesday signal that officials will make three rate hikes next year and another three in 2023. Median forecasts by Fed officials see the benchmark rate rise to 0.9% in 2022 from 0.1% and still higher to 1, 6% in 2023.

Maximum employment is only a year away

Powell made it clear at this afternoon’s press conference that the economy is making healthy progress toward achieving the Fed’s goal of maximum employment. With inflation well above the Fed’s target of an average of 2%, the employment target remains the factor that keeps the Fed from fully reversing its pandemic policy.

The country is “making rapid progress” toward the maximum employment target, Powell said, adding that all participants in the Federal Open Market Committee expect the criterion to be met by 2022.

The central bank’s latest forecasts support the optimistic outlook. Unemployment is expected to fall to 3.5% and remain at the historically low level through 2024. This is an improvement over the September projection, where the rate only fell to 3.8% next year before reaching 3.5% in 2023

At the same time, the shortage of labor will make the employment recovery look different than before, Powell said, adding that it is “unclear” how long the trend will last. Job openings rose close to record highs in October, while layoffs remained high. With nearly 7 million Americans still unemployed, trends suggest companies will struggle to attract workers well into 2022.

Labor force participation is slowly recovering, but a complete recovery may not happen “for some time,” Powell said.

“The labor market is by so many goals hotter than it has ever run in the last expansion, if you think about it,” he added.

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