WASHINGTON — As inflation punishes consumers and threatens the economy, the Federal Reserve will likely signal this week that it intends to begin raising interest rates in March for the first time in three years. The Fed’s challenges will get harder and harder from there.
Among central bank officials, there is broad support for a rate hike – one that would come much sooner than officials expected just months ago. But after that, their policymaking will become more complicated and could sow internal divisions, especially as a number of new officials join the Fed.
How many times, for example, is the Fed expected to raise rates this year? When should it start shedding its huge stockpile of bonds, a move that would help tighten credit? And how should the Fed react if inflation slows later this year, as many officials expect, while remaining well above its annual target of 2%?
Some economists have expressed concern that the Fed is already acting too late to tackle high inflation. Others say they fear the Fed is acting too aggressively. They argue that many rate hikes would risk provoking a recession and would in no way slow inflation. From this perspective, high prices primarily reflect tangled supply chains that Fed rate hikes are powerless to remedy.
“The consensus is that now is the time to move on,” said Roberto Perli, chief economist at Cornerstone Macro and a former Fed staffer. “The debate is about speed.”
When the Fed raises its short-term rate, it tends to make borrowing more expensive for consumers and businesses, which slows down the economy in an effort to reduce inflation.
Spooked by the prospect of higher rates, investors dumped stocks with abandon. Last week, a selloff sent the S&P 500 index into its worst weekly loss since the pandemic erupted in March 2020. The tech-heavy Nasdaq fell more than 10% from its peak, which amounts to a “correction” in its own right.
This week’s Fed meeting, which ends with a policy statement and press conference with Chairman Jerome Powell on Wednesday, is taking place against the backdrop of soaring inflation and an economy reeling from another wave. of COVID-19 infections. Over the past year, consumer prices have jumped 7%, the fastest pace in nearly four decades.
Powell acknowledged that he had not anticipated the persistence of high inflation, having long expressed the belief that it would be temporary. The spike in inflation has spread to areas beyond those hit by supply shortages – apartment rents, for example – suggesting it could persist even after goods and coins flow more freely.
One of the reasons Fed officials appear to be unanimous on an initial rate hike is that unemployment has fallen surprisingly fast. At just 3.9% in December, the unemployment rate is near a five-decade low reached before the pandemic. Economists expect Fed officials to signal this week that they have achieved their goal of maximizing employment, paving the way for a hike in their near-zero benchmark short-term rate. The Fed had cut that rate to help the economy after the pandemic triggered a sharp recession.
Some observers have suggested that the Fed could even raise its benchmark rate by half a percentage point in March, double the usual size. But Diane Swonk, chief economist at consultancy Grant Thornton, said she thought a half-point rate hike was unlikely.
“That would signal a real panic,” she said. “The Fed likes things orderly.”
Powell now chairs a more hawkish central bank as four new regional federal bank presidents, out of a total of 12, hold voting positions, which happens every year. (“Hawks” tend to worry about the risk of inflation being too high; “doves” favor relatively low rates to reduce unemployment.)
This year’s new Fed voters include three who have expressed hawkish views: James Bullard of the Federal Reserve Bank of St. Louis, Loretta Mester of the Cleveland Fed and Esther George of the Kansas City Fed. They replace some more dovish chairs, including San Francisco Fed’s Mary Daly and Chicago Fed’s Charles Evans.
Yet even dovish officials expressed support for rate hikes as early as March. Goldman Sachs counts eight Fed policymakers, of the 16 currently in meetings, as supporting higher rates.
“I definitely see rate increases coming, even as early as March,” Daly said in an interview with PBS. “Because it’s really clear that prices have been uncomfortably high.”
Chairman Joe Biden has meanwhile appointed three people to fill vacancies on the Fed Board of Governors. Governors have standing votes on pricing policies. All three — Sarah Bloom Raskin, who previously served as Fed governor, and Lisa Cook and Philip Jefferson — are seen as fairly dovish, a formation that could create potential internal divisions later this year if confirmed by the Senate.
Most economists predict four rate hikes this year, although the CME Group, which tracks futures trading, finds investors are expecting at least five. Testifying before the Senate Banking Committee earlier this month, Powell appeared to hint at the likelihood of more rate hikes, saying the Fed was now far from a “normal” level of interest rates.
“It’s really time for us to move away from these pandemic emergencies to a more normal level,” he said. “It’s a long way to normal from where we are.”
Still, Powell and the Fed have more than rate hikes to consider. The Fed is phasing out its $120 billion in monthly bond purchases, which were aimed at keeping long-term rates low. These purchases will end in March.