According to the minutes of their last meeting, the Federal Reserve may need to raise interest rates “sooner or faster” than officials originally expected in order to curb uncomfortably high inflation and promote a stable economic recovery.
Minutes of the December meeting of the Federal Reserve’s Open Market Committee, released on Wednesday, showed officials wholeheartedly approve of plans to reduce the asset-purchase program launched at the beginning of the pandemic more quickly in order to give the central bank more flexibility the rate hike to give prices next year.
The minutes provide additional details on why the Fed made a sharp swing in late 2021 to take a more aggressive approach to removing its adaptability from financial markets, and how the central bank might proceed with various monetary policy adjustments this year.
A sell-off in US stocks accelerated after the minutes were released, with the S&P 500 down more than 1 percent and the tech-heavy Nasdaq Composite down 3 percent that day. Short-dated US Treasuries were also sold, with the two-year yield hitting 0.83 percent, its highest level since March 2020.
The December meeting also saw the first substantial discussion of the Fed’s balance sheet, which has more than doubled since early 2020 and is now just under $ 9 trillion.
The minutes indicate broad support for the Fed to begin reducing its balance sheet after the first rate hike. Some said a move could be “relatively soon” afterwards.
“Some participants felt that a less accommodating future policy stance would likely be warranted and that the committee should convey a strong commitment to dealing with heightened inflationary pressures,” the minutes read.
According to the so-called dot-plot of the individual interest rate forecasts released by the Fed after its December meeting, officials expect to hike rates three times over the next year, with three more steps planned for 2023 and two more for 2024.
In September, Fed officials were equally divided over the prospect of raising the key rate from near zero this year.
Christopher Waller, a central bank governor, later suggested that the first rate hike could even come as early as March, as the stimulus plan is suspended altogether.
According to the protocol, policymakers stressed the importance of remaining flexible with future policy adjustments, especially given the pace of economic recovery.
“Participants generally noted that given their individual outlook for the economy, labor market and inflation, it might be justified to raise the key rate sooner or faster than participants previously expected,” the minutes read.
Inflation has come in far more than Fed officials originally anticipated in the early days of the pandemic recovery. Recent pressures suggest a growing risk that increased consumer prices will lock in.
The minutes highlight particular concern that the supply chain bottlenecks and labor shortages that have contributed to rising prices are likely to be “longer and more widespread than originally thought”.
Speaking at the news conference after the December meeting, Fed chairman Jay Powell said inflation levels were “not at all” what the Fed was looking for when it announced in August 2020 that it would tolerate higher inflation to offset past periods in which the long-term target of 2 percent was not achieved.
One of his favorite indicators, the consumer spending price index, saw annual growth of 5.7 percent in November, the highest level in about four decades.
Fed officials have raised their inflation projections accordingly, with the core measure – which excludes volatile items like food and energy – now expected to hover at 4.4 percent in 2021 before falling further to 2.7 percent in late 2022. FOMC members and other regional association presidents also lowered their unemployment rate targets, which stand at 4.2 percent. It is expected to drop to 3.5 percent by the end of 2022.
The central bank is committed to keeping interest rates near zero until it hits an average of 2 percent inflation over time and maximum employment.
The first threshold was “more than fulfilled”, it said in the minutes, “several” participants already saw the labor market conditions “largely in line” with the second goal.
Some participants even suggested the Fed could hike rates before maximum employment is fully reached, especially if inflationary pressures continue to mount.
The market-implied chances of a rate hike in March rose on Wednesday as investors digested the restrictive bias.
However, a concern officials raised in discussing their plans to wind down adjustments was the resilience of the treasury market, with “multiple” participants addressing “vulnerabilities” that could limit the Fed’s pace of downsizing its balance sheet.