Fed to wind-down bond purchases, signals three rate hikes in 2022

• Fed announced quicker wind-down of bond purchases

• The central bank indicated to raise the interest rate thrice in 2022

The Federal Reserve on Wednesday said it would end its bond purchases in March 2022 and will gradually increase the interest rates by the end of the following year, signaling that the inflation target has been met.

In the new economic projections, the Fed forecasts that inflation would run at 2.6% next year, compared to the earlier prediction of 2.2%, and the unemployment rate would fall to 3.5%.

Following the end of a two-day policy meeting, the central bank said it would be buying $60 billion of bonds each month starting January and will end the program by March.

That’s half the level before the November taper and $30 billion less than it had been buying in December.

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The central bank indicated that after the bond purchase wraps up in March, it will start raising interest rates, which were held steady at this week’s meeting.

Projections released Wednesday directed that Fed will increase the interest rates three times in 2022, with twice in 2023 and two more in 2024.

The S&P 500 index jumped nearly 1.6%, while the tech-heavy Nasdaq Composite surged over 2%. The Dow Jones Industrial Average added 382 points. All three major U.S. indexes were in negative territory for the day before Fed’s decision.

Transitory inflation

The Federal Open Market Committee’s (FOMC) move represents a substantial change to the policy that has been the most lenient in its 108-year history, enacted at the start of the health crisis. 

“Supply and demand imbalances related to the pandemic and the reopening of the economy have continued to contribute to elevated levels of inflation,” the statement said.

The statement also noted that “job gains have been solid in recent months, and the unemployment rate has declined substantially.”

The policy change came in response to mounting inflation, which is running at its highest level in 39 years for consumer prices, with prices in November jumping 9.6%, the fastest on record.

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Fed officials have long stressed that inflation is “transitory,” which Fed Chair Jerome Powell has defined as unlikely to leave a lasting imprint on the economy.

Powell and Treasury Secretary Janet Yellen have said that increasing price pressure is due to pandemic-related factors such as extraordinary demand that has surpassed supply but ultimately will fade.

“The word transitory has different meanings for different people. To many, it carries a sense of short-lived. We tend to use it to mean that it won’t leave a permanent mark in the form of higher inflation,” Powell earlier in December said. “I think it’s probably a good time to retire that word and try to explain more clearly what we mean.”

Normalizing policy

Though the central bank made any rate hikes contingent on some improved job market, the new policy projections will increase the borrowing costs next year.

All 18 policymakers indicated that a single interest rate hike would be appropriate before the end of 2022.

The new projections began to pin down the Fed’s plan to “normalize” monetary policy following nearly two years of extraordinary efforts to guide the U.S. economy through the pandemic.

However, the Fed acknowledged that the new Omicron variant of coronavirus would add to the uncertainty.

Picture Credit: ForexLive