WASHINGTON—The Federal Reserve announced on Sept. 22 that it would keep U.S. interest rates near zero as “risks to the economic outlook remain.” The central bank signaled that it could slow its monthly bond purchases “soon” as a first step toward normalizing monetary policy.
Fed officials also revised up their inflation projections significantly for this year and downgraded their growth forecasts to reflect the economic impact of the Delta variant of COVID-19.
“The sectors most adversely affected by the pandemic have improved in recent months, but the rise in COVID-19 cases has slowed their recovery. Inflation is elevated, largely reflecting transitory factors,” according to the revised statement from the Federal Open Market Committee (FOMC).
At the end of a two-day meeting of the committee, Fed officials stated that they would hold the federal funds rate at a range of zero to 0.25 percent, in line with expectations. New projections released after the meeting showed that nine out of 18 FOMC participants expect rate increase next year, up from seven who predicted that would be possible in June.
In addition to the rise in virus cases, supply chain constraints have restrained economic activity, Chairman Jerome Powell noted at a post-meeting press conference.
“These constraints are particularly acute in the motor vehicle industry, where the worldwide shortage of semiconductors has sharply curtailed production,” he said.
This week’s FOMC meeting was crucial in providing important clues about the Fed’s normalization plans, which includes the tapering of its asset purchases.
According to the Fed’s statement, “if progress continues broadly as expected, the Committee judges that a moderation in the pace of asset purchases may soon be warranted.”
The central bank continues to buy at least $120 billion per month of Treasuries and mortgage-backed securities to support the economy and the flow of credit during the pandemic. Continuation of this policy is troubling, critics say, as it stokes inflation.
Fed officials “generally view that so long as the recovery remains on track, a gradual tapering process that concludes around the middle of next year is likely to be appropriate,” Powell said.
The Fed’s inflation projections increased materially for this year, with core inflation at 3.7 percent compared to 3.0 percent forecasted in June. The inflation forecasts beyond this year haven’t changed significantly.
Fed officials expect that median growth for 2021 will fall by more than a percentage point to 5.9 percent this year. The growth projection in June was 7 percent. They, however, revised their growth projection for 2022 to 3.8 percent from 3.3 percent.
The unemployment rate remained mostly unchanged except for a slight upward revision to this year, to 4.8 percent from 4.5 percent.
Employers added a disappointing 235,000 jobs in August. But this unexpected slowdown is unlikely to affect the Fed’s plans to reduce its asset purchases this year.
Powell indicated that the Fed wouldn’t change its plans if the next jobs report isn’t a “super strong” one.
“I don’t personally need to see a very strong employment report, but I’d like to see a good, decent employment report,” he said.
He noted, however, for a rate liftoff, the bar is “much higher” and didn’t anticipate an increase in rates before the end of the taper.
Scott Anderson, chief economist at Bank of the West, predicts that the official announcement for tapering will come at the upcoming FOMC meeting in November.
“We are looking for a $15 billion reduction in monthly asset purchases when the taper commences, taking about 8 months to complete,” he wrote in a note.
With respect to rate increases, however, Anderson believes projections by Fed officials are “a bit too aggressive.”
“At this point, we would still not expect any Fed rate hikes in 2022 and maybe two quarter-point rate hikes in 2023 and 2024,” he wrote.
“What is clear is that inflation is likely to be the determining factor for liftoff and the pace of rate hikes,” Deutsche Bank’s chief U.S. economist Matthew Luzzetti wrote in a report.
If core inflation slows down to the Fed’s 2.3 percent forecast next year, the liftoff could be possible in 2023, he said.
“However, if inflation proves to be higher with inflation expectations continuing to rise, the first rate increase could well migrate into 2022.”
During the press conference, Powell also addressed questions regarding the two senior Fed officials who engaged in trading activity in 2020.
“We understand very well that the trust of the American people is essential for us to effectively carry out our mission,” Powell said.
The Fed will conduct a “comprehensive review” of ethics rules, he said, and find ways to further tighten rules and standards for Fed officials’ trading and investment activity.