Federal Reserve officials are piling up around a plan to continue raising interest rates beginning in March and then move quickly to reduce the central bank’s large bond holdings as policymakers grapple with a moment of rapid inflation. Let the economy cool down.
While policymakers are likely to keep an eye on the conflict in Ukraine as they move forward with those plans, for now the geopolitical developments are not enough to derail the central bank’s campaign to hold back price hikes.
Policymakers have spent the past week broadcasting that their March meeting plans for an interest rate hike – one that investors are already fully anticipating – will be the first in a string of rate moves. Central bankers were also mulling over a plan to immediately reduce the Fed’s holdings of government-backed debt, which were largely expanded during the pandemic’s recession as the Fed announced a plan to work markets and cushion the economy. Bonds were broken in the bid.
The central bank made $120 billion purchases in Treasury and mortgage-backed securities for 2020 and 2021, but officials are reducing those purchases and on track to stop them altogether in March. By quickly pivoting to allow the securities on its nearly $9 trillion balance sheet to be liquidated without reinvestment — reducing its holdings over time — the Fed would take away a significant source of demand for government-backed debt and the rates on those securities. will increase it more. This would work in conjunction with a higher Fed policy interest rate to make many types of lending more expensive.
The higher cost of borrowing should help slow lending and spending, spurring demand and slowing price gains, which have happened uncomfortably fast. This week’s data is expected to further lift the central bank’s preferred inflation gauge, which was already moving at the fastest pace in 40 years.
The Fed governor, Lyle Brainard, who has been nominated by President Biden to serve as vice president, said last week that he believed a “series” of rate hikes was warranted.
“I expect it to be appropriate to introduce a series of rate increases at our next meeting, which is just a few weeks away,” he said Friday at a forum hosted by the University of Chicago’s Booth School of Business. New York. Ms Brainard said the Fed would then turn to shrinking its balance sheet, a process that may be appropriate to begin “in the coming meetings”.
Another Fed governor, Michelle Bowman, echoed that balance sheet reduction could begin imminently, saying in a speech on Monday that the Fed will need to begin reducing its bond holdings “in the coming months.”
The exact timing of shrinking the balance sheet is a matter of debate. John C. Williams, chairman of the Federal Reserve Bank of New York, suggested on Friday that the process could begin “later this year,” suggesting that in the coming months or a little later. But executives have been equally clear that a pullback is coming, and possibly more quickly than investors have expected recently.
Although policymakers plan to reduce their holdings of Treasury bonds and mortgage-backed securities by allowing them to liquidate instead of selling off the debt, the Fed’s latest meeting minutes suggested that officials may eventually sell mortgage-backed securities outright. Can proceed for sale. The minutes also suggested that officials thought “a significant reduction” would be needed in the balance sheet.
The pace of the move will be faster than the last time the Fed raised interest rates from 2015 to the end of 2018. Then, officials gradually slashed the balance sheet and raised interest rates glacially, the fastest once per quarter.
Borrowing costs have already begun to rise as investors adjust to the Fed’s more rapid-fire plans. The market expects the interest rate to increase in six or seven quarters this year. When the Fed began its policy pivot, the rate on 30-year mortgages rose to 3.9 percent from about 2.9 percent the previous fall.
The Fed’s policy change will “bring down inflation over time, while maintaining a recovery that is all-encompassing,” said Ms. Brainard, as the Fed signals it will raise rates, “the markets clearly align with Is.”
But tensions between Russia and Ukraine could create both additional inflationary pressures and a risk to growth. So far, there has been little sign that the result will be enough to prompt the Fed to change course.
“The Federal Reserve pays a lot of attention to geopolitical events, and that is certainly the most prominent at this point,” Ms Bowman said Monday before tensions escalated.
“We believe there is significant opportunity for potential impacts on energy markets as we move forward, if things worsen,” she said.
Oil and gas prices have already risen during the conflict and could continue to climb, leading to higher peaks in headline inflation, including prices at the pump. The Fed generally avoids reacting to energy price fluctuations when setting its policy, given their volatility, but the potential disruption could make inflationary trends more painful for consumers.
Federal Reserve Bank of Atlanta President Rafael Bostic said during a virtual event on Tuesday that the uncertainty over the situation posed some risk to the US economy and it was unclear what effect the sanctions might have on economic growth.
Assessing exactly what the conflict between Russia and Ukraine will mean for the US economy is challenging because it is unclear how much tensions will escalate and because it is unclear how Russia might respond as the US and Europe impose sanctions. Huh.
“My administration is using every tool at our disposal to protect American businesses and consumers from rising prices at the pump,” Mr Biden said during a briefing on Tuesday. He said there would be a “cost to defend freedom” but that his administration was taking action to ensure that any economic pain was directed at the Russian rather than the American economy.
He said the White House is “closely monitoring” energy supply and planning with major energy producers to blunt the impact on gas prices.
For now, with inflation accelerating, wage growth strong and signs of tense labor market conditions plentiful, some Fed officials worry the central bank needs to move even faster.
For example, Ms Bowman said on Monday she was still set for a half-percent increase in March – something that even Federal Reserve Bank of St. Louis President James Bullard has suggested.
“I will look closely at the data at the March meeting to judge the appropriate size of the increase,” said Ms Bowman.
But Mr Bullard, who has repeatedly said he would love to see a full percentage increase in rates by July, has also noted that he would like to discuss the size of the initial hike with Jerome H. Powell’s chair. And other members of the Fed’s policy-making committee have suggested they don’t think it’s necessary to start with a half-point increase, suggesting that a smaller increase may be more likely.
“There’s really no compelling argument that you have to be quick in the beginning,” Williams, president of the mighty Federal Reserve Bank of New York, told reporters last week.
