The Federal Reserve Is Planning To Increase Interest Rates In March

Philip Popovic

On Wednesday, the Federal Reserve indicated that interest rates could soon rise during an easing of historically dovish monetary policy to deal with both turbulent financial markets and raging inflation.

Rather than surprise anyone, members of the Fed's policymaking group announced that their benchmark short-term borrowing rate would likely rise by a quarter percent point. There hasn't been a hike since December 2018.

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Fed chair Jerome Powell said the Fed may act aggressively.

Powell said at his post-meeting news conference that the labor market can be protected without raising interest rates too much. Following Powell's announcement, major stock market averages turned negative after being strong earlier in the day.

Inflation has reached the highest level in almost 40 years, prompting the committee's statement. Markets have been very choppy in recent days as investors worried that the Fed might tighten policy more than expected despite the fact that the move toward a less accommodative policy has been well-telegraphed over the past several weeks.

Despite indications that the Federal Open Market Committee is poised to increase rates soon, no specific date was provided in its post-meeting statement. The statement was unanimously approved by the committee.

With inflation higher than 2 percent and a strong labor market, it is expected that raising the federal funds rate target range will soon be appropriate, the statement added.

The committee also discussed the central bank's monthly bond-buying program which will be only $30 billion in February, indicating the program will end in March in conjunction with rising interest rates.

The Fed provided no specific indication Wednesday when it might begin reducing the nearly $9 trillion of bonds on its balance sheet.

Nevertheless, the committee released a statement outlining "principles for reducing the size of the balance sheet." The statement states that the Fed is prepared to "significantly reduce" the level of asset holdings.

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Policymakers noted that benchmark funds rates were a key tool for adjusting monetary policy. They also noted that the bank would reduce its balance sheet "predictably," by adjusting how much of bond proceeds would be reinvested and how much rolled off.

Michael Pearce, senior U.S. economist at Capital Economics, says the Fed's announcement that rates will 'soon be appropriate' is clear evidence of a March rate hike. Fed plans to run down its balance sheet as soon as rates rise, so hawkish announcements on that could also come at the next meeting.

The markets eagerly awaited the Fed's decision.

As a result, investors expect a more aggressive schedule of rate hikes this year than the FOMC officials predicted in December. The CME's FedWatch tool, which calculates forecast probabilities through the Fed Funds futures market, shows that the committee penciled in three 25 basis point moves this year, while the market is pricing in four.

According to traders, the funds rate will be about 1% at the end of the year, up from its near-zero range right now.

After months of claiming price increases were temporary, the Federal Reserve has expressed concern about persisting inflation. Consumer prices are up 7% from a year ago, the fastest 12-month growth since 1982.

Since inflation has remained strong, officials have rethought monetary policy, which has produced the easiest monetary policy in the history of the Fed. As a consequence of the COVID pandemic, the central bank cut its benchmark interest rate to 0%-2.5% and has been buying Treasury obligations and mortgage-backed securities by the billions each month.

Powell said that part of that process would be that the Fed would move away from very accommodative policy to substantially less accommodative policy and eventually to a policy that is not accommodative.

In addition to bond purchases, the Fed has purchased nearly $9 trillion worth of assets on its balance sheet as a result of quantitative easing. The Fed will probably wait several months and then start allowing some proceeds from its bond holdings to run off each month while reinvesting the rest. Now, that money is reinvested by the Fed.

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Powell stated that the balance sheet was large compared to what it was needed to be. A substantial amount of shrinkage needs to be done to the balance sheet. It will take time to complete. It should run in a predictable and orderly manner.

It has been reported recently that Goldman Sachs expects the runoff of balance sheet assets to begin in June at a pace of $100 billion a month, about double what it did with the previous runoff a few years ago.

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