Fed divided on 2022 interest rate hike, signals impending cut in bond purchases

The Federal Reserve signaled on Wednesday that a rate hike may now be justified as early as next year and that it is set to reduce the number of bonds it purchases each month – steps that illustrate the increased confidence central bankers in the US economy despite the headwinds of slower growth and the Delta variant.

Officials kept their key debt benchmark at 0-0.25%, where it has been since the coronavirus pandemic entered the economy.

Still, half of Fed policymakers are forecasting at least one interest rate hike in 2022 and three policymakers are forecasting at least two hikes in the year, according to the latest Summary of Economic Projections. These would be the first rate hikes since 2018, reflecting a Fed that is becoming considerably more hawkish. In July, policymakers expected rates to take off for the first time at least twice in 2023. Only one participant sees rates suspended until 2023.

Meanwhile, officials said the US economy has made “progress” toward maximum employment and price stability, the Fed’s dual purpose of restoring more normal monetary policy as the economy recedes. recovering from the pandemic. The wording suggests that the Fed is set to announce a formal decision on when and how much it plans to slow its monthly bond purchases by $ 120 billion.

“If progress continues broadly as planned, the committee believes that moderation in the pace of asset purchases may soon be warranted,” the Federal Open Market Committee (FOMC) said in its post-meeting statement.

These decisions all have major implications for consumer wallets. The federal funds rate influences how much consumers pay to take on short-term debt, from auto loans to credit cards, while the yields on savings accounts and certificates of deposit (CDs) follow rate movements. in parallel. The Fed’s asset purchases, on the other hand, influence longer-term borrowing, such as mortgage rates and refinancing rates, as well as expectations about inflation and economic growth.

“The Federal Reserve has planned the option of announcing a start of reduction at its next meeting in November, while keeping its options open in the meantime if the Delta variant or the debt cap delays the economic recovery,” said Greg McBride, CFA, Chief Financial Analyst of Bankrate.

The Fed faces an uneven economic context

The Fed is putting more emphasis on getting Americans back to work, hoping to keep the economy running long enough to help the estimated 5.6 million missing workers get back to work. That means keeping interest rates low for longer, but officials are grappling with an uneven outlook, making the typical juggle between maximum employment and stable prices trickier than usual.

Consumer prices rose the most in August in 13 years, while the Fed’s preferred method of tracking inflation rose the most in July since the early 2000s, according to recent figures from the Department of Labor and of the Ministry of Commerce.

The Fed now wants inflation to average 2% over time, but price increases this year have averaged 3% and are on track to exceed that number. In the air is how much these increases have to do with temporary factors, with disrupted supply chains, shortages, high consumer demand and below-average readings from last year in the mix. Consumers, however, are starting to expect inflation at a certain level to be here to stay, giving businesses more leverage to raise prices and risking price hikes to become more sustainable.

At the same time, mixed signals are complicating how officials can keep up with peak employment. About 8.3 million workers remain unemployed, unemployment is historically high and employers are adding jobs at a moderate rate, according to the August jobs report. Some measures suggest the job market may be tighter than officials think, with job vacancies in August reaching a record 10.9 million, beating the number of unemployed.

Officials attributed this to continued apprehension of the virus, restrictions on childcare and increased unemployment benefits – which expired on September 6. Yet exits and retirements may have permanently reduced the pool of available workers. The Fed needs more time to say what’s going on, but surging inflation could test that patience.

The Fed refines its rate hike outlook

This economic environment is putting more pressure on the Fed’s rate hike outlook, as officials are increasingly less patient in keeping rates low in their latest projections.

Quarterly projections showed that half of officials (9 of 18) preferred to hike interest rates in 2022, down from just seven in June. Meanwhile, the Fed policymakers’ median projection for 2023 showed the fed funds rate within a target range of 1% to 1.25%, a percentage point higher than it is now.

The Fed also provided clues to its rate projections for 2024, with the median estimate of Fed policymakers pointing to a fed funds rate in a target range of 1.5 to 1.75% for the year.

While these projections are not official forecasts and the outlook may change, they still reflect growing confidence in the economy.

The dots say, “We can do a healthy dose of loosening monetary policy, and they think the economy would be strong enough for that,” said Mark Fleming, chief economist at First American Financial Corporation. “You don’t apply the brakes right before you hit the car in front of you; you start to apply the brakes long before you get there. They believe the economy is strong, that it will continue to be strong and growing, and that we need to start slowing monetary policy as soon as possible. “

Economic forecasts by policymakers were mixed, however. Officials see their preferred measure of price gains rise 4.2% in 2021 – up from their previous projection of 3.4% in June – while increasing 2.2% in 2022 and 2023.

At the same time, policymakers no longer expect unemployment to drop so much in 2021 (revising their unemployment forecast to 4.8% from 4.5% in June), reflecting concerns about the Delta variant, Powell told reporters at a press conference after the meeting.

The Fed sees unemployment drop to 3.8% in 2022 and 3.5% in 2023, then stay there until 2024.

The US economy, through its broadest scorecard, has already recovered most of the ground lost to the pandemic, with gross domestic product (GDP) already exceeding pre-epidemic levels. The Fed’s extraordinary accommodations and massive fiscal stimulus since the onset of the crisis help fuel momentum, with President Joe Biden and former President Donald Trump each signing their own massive $ 2 trillion packages – who both sent stimulus checks to consumers and increased unemployment benefits.

The ultimate question, however, is how well that pace can be sustained. Economists expect the best economic performance in nearly four decades this year, but that high sugar level may fade as the stimulus works its way through the system. More headwinds from the Delta variant could threaten to weigh on the rebound, keeping consumers nervous at home and more workers on the sidelines. On Monday, stocks fell the most in four months, as investors faced concerns over slowing growth and China’s real estate sector.

Regarding GDP, policy makers have revised their growth forecasts for 2021 downwards (5.9% compared to 7% in June), but have revised these projections upwards for 2022 and 2023.

Powell said no decision on asset reduction has officially been made, meaning the Fed wants to reserve the right to be flexible if the outlook darkens. But he strongly suggested that the withdrawal could take place as early as his November meeting, adding that further substantial progress in the labor market had been “almost achieved”.

“Participants generally felt that as long as the economic recovery stays on track, a phase-down process that ends around the middle of next year is likely to be appropriate,” said Powell. “We could easily go ahead at the next meeting – or not, depending on whether we think those tests are satisfied.”

What this means for you

Higher prices can undermine your purchasing power, but consumers and investors still have steps they can take to minimize the impact.

Manage a diversified portfolio with investments traditionally protected against inflation, from dividend paying stocks and preferred stocks to real estate investment trusts. During this time, avoid leaving too much cash in fixed income investments, such as bonds, which tend to be more sensitive to price increases.

Experts also say refinancing your mortgage could be a crucial way to free up money – money you can use to bolster your emergency fund or to pump up your wallet to offset rising prices. A July Bankrate survey found that 74% of Americans with mortgages had yet to refinance despite record rates, meaning you didn’t miss the opportunity.

Even once the Fed begins to slow down its bond buying, mortgage rates aren’t exactly destined to rise, experts say. Even so, don’t wait too long. Refinance rates are sensitive and fluctuate from week to week, which means it’s never a bad time to assess your finances and compare rates with other lenders in the market.

Consumers with high cost credit card debt will be better off if they can eliminate their excess balances now, when rates are still low. Analyze how much you would save in interest by estimating the cost of transferring your debt to a balance transfer card.

And while market participants may dread the idea of ​​less monetary stimulus, consumers and investors should applaud the news when it arrives, reflecting the economy is recovering from its worst crash ever. Nothing better for your portfolio, your investments and your job prospects than a solid perspective and sustainable growth.

“There is this worry or fear that a tighter monetary policy is always riskier than letting it loose or slacking it, but I would counter it,” Fleming said. “We can have a less flexible monetary policy while still having a growing economy that works well. “

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