The Federal Reserve signaled on Jan. 26 that it will likely raise U.S. interest rates in March for the first time in more than three years in an effort to tighten monetary policy.
The Fed’s rate-setting Federal Open Market Committee (FOMC) had been deliberating on how to refocus the Fed’s monetary policies in a two-day policy meeting.
The central bank reaffirmed its plans to end bond purchases in March, after a final round of asset purchases, as part of what it calls a significant reduction in its asset holdings.
The FOMC stated it would “continue to reduce the monthly pace of its net asset purchases, bringing them to an end in early March,” and that it “will increase its holdings of Treasury securities by at least $20 billion per month and of agency mortgage‑backed securities by at least $10 billion per month,” beginning in February.
Both moves would fulfill the Fed’s abandonment of a historically loose monetary policy that has been the rule since the start of the pandemic, in an urgent fight to combat inflation.
Fed Chairman Jerome Powell, at a news conference following the two-day policy meeting, said the U.S. central bank will be open-minded as it adjusts monetary policy to keep persistently high inflation from becoming entrenched.
“At this time, we haven’t made any decisions about the path of policy,” Powell said. “I stress again that we’ll be humble and nimble.”
Fed policymakers have “quite a bit of room to raise interest rates without threatening the labor market” as they remove the extraordinary support provided during the pandemic. “The economy is quite different this time,” Powell said.
The FOMC stated that its goal is to achieve maximum employment and inflation at the rate of “2 percent over the longer run” and therefore “decided to keep the target range for the federal funds rate at 0 to 1/4 percent.”
“With inflation well above 2 percent and a strong labor market, the Committee expects it will soon be appropriate to raise the target range for the federal funds rate,” the FOMC said in a statement.
The Fed’s $9 trillion securities portfolio has more than doubled since March 2020, after it cut short-term interest rates to near zero and purchased bonds to lower long-term rates in a program called quantitative easing.
“The balance sheet is substantially larger than it needs to be,” Powell said.
“There’s a substantial amount of shrinkage in the balance sheet to be done. That’s going to take some time. We want that process to be orderly and predictable.”
The policymakers released their agenda on how they will significantly reduce those holdings in a separate one-page statement.
The Fed plans to reduce its asset holdings primarily by allowing some of the proceeds from its bond holdings to run off monthly while reinvesting the rest.
That plan will likely start after the liftoff in interest rates.
It’s hoped that the Fed’s massive balance sheet would be pared down over time by shifting away from mortgage-backed securities and weighing it toward U.S. Treasurys, to “thereby minimizing the effect of Federal Reserve holdings on the allocation of credit across sectors of the economy,” according to the statement.
The Fed cited solid job gains and low unemployment levels, despite the outbreak of the Omicron variant.
The FOMC statement noted that “supply and demand imbalances related to the pandemic and the reopening of the economy have continued to contribute to elevated levels of inflation.”
The concerned statement from the Fed comes after months of persistent inflation, which the Fed had earlier downplayed as transitory.
Consumer prices are increasing at a 7 percent annual rate, the fastest 12-month pace since the summer of 1982.
Fed officials said they weren’t assessing when inflation might ease, but were optimistic that improvements in the global supply chains would ease the rate of price increases.
Despite the Fed’s statement being well telegraphed, stocks fell after the Federal Reserve released the statement, ending a long trading day that reversed earlier gains.
The S&P 500 closed down 6.52 points, or 0.1 percent, to 4,349.93.
The Nasdaq Composite Index ticked up 2.82 points, or less than 0.1 percent, to 13,542.12, while the Dow Jones Industrial Average fell 129.64 points, or 0.4 percent, to 34,168.09.