Federal Reserve officials this week hinted at plans to raise interest rates in March to combat rising inflation – marking the first change to the agency’s benchmark rate since December of 2018. 

Officials are also expected to announce a final round of asset purchases and to resume talks on how to how to ‘significantly reduce’ the Fed’s nearly $9 trillion balance sheet. Goldman Sachs predicts the agency will try to shed $100 billion a month starting in July. 

The Fed believes a rate increase will help slow the pace of hiring and income growth, resulting in decreased demand and decreased inflation. Other factors expected to calm inflation include:

  • A shift in demand from goods to services.
  • Supply chain issues being resolved.
  • The Fed’s potential elimination of mortgage-backed securities from its balance sheet.

“If they want to tighten financial conditions, they want to slow inflation, the number-one contributor to inflation in 2022 is going to be housing-related inflation,” says Barry Knapp, head of research at Ironsides Macroeconomics. “Goods prices will come down, supply chains will clear. But that increase in housing prices and rental prices, that just is going to keep going up. It’s already above 4%. The Fed’s primary channel for slowing inflation in this case is via the housing market.”

Speaking to lawmakers earlier this month, Federal Reserve Chairman Jerome Powell claimed that rising inflation is a result of changes to supply and demand: “Supply and demand imbalances related to the pandemic and the reopening of the economy have continued to contribute to elevated levels of inflation.”

When the central bank cut interest rates to near zero in March of 2020, officials said rates would remain low until unemployment improved and until inflation was projected to exceed 2%.

Inflation jumped to 4.7% in November of 2021 before dipping to 3.9% in December and has not improved since. Consumer prices are increasing at roughly 7% – the highest since 1982.

The unemployment rate is currently about 3.9% compared to 3.5% before the pandemic and down from a peak of 14.8% in April of 2020.

With both of the Fed’s conditions for a rate increase having been met, the agency is expected to hike rates by .25% or more in mid-March. 

Economists predict between two and five additional increases by the end of the year and at least three next year, but this strategy could change if inflation remains above 3%.

“To the extent that [the] situation deteriorates further, our policy will have to reflect that,” notes Powell. “This is going to be a year in which we move steadily away from the very highly accommodative monetary policy we put in place to deal with the economic effects of the pandemic.” 

Other factors that may cause the Fed to change its strategy include stock market activity, COVID variants, and whether Russia takes action against Ukraine. 

The S&P 500 dipped 11% in response to the agency’s announcement this week, but yields on Treasury securities increased. 

Author’s Note:

In the words of my colleague Joe Gilbertson, the problem with a rate increase is that it also raises the interest owed on our national debt and prompts the government to print more money (or raise taxes or cut spending – neither of which they seem capable of), which causes inflation to rise. 

Sources:
Fed Expected to Signal Interest-Rate Increases to Start in March 

https://www.wsj.com/articles/fed-expected-to-signal-rate-increases-to-start-in-march-11643193004

Fed likely to hike rates in March as Powell vows sustained inflation fight 

https://www.reuters.com/business/finance/inflation-fighting-fed-likely-flag-march-interest-rate-hike-2022-01-26/

The Fed is likely to signal a March interest rate hike and that further policy tightening is coming 

https://www.cnbc.com/2022/01/25/the-federal-reserve-is-likely-to-signal-a-march-rate-hike.html

Inflation surge could push the Fed into more than four rate hikes this year, Goldman Sachs says 

https://www.cnbc.com/2022/01/23/inflation-surge-could-push-the-fed-into-more-than-four-rate-hikes-this-year-goldman-sachs-says.html

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