The Fed to indicate the timing, speed of raising interest rates to calm inflation

WASHINGTON – The Federal Reserve will indicate on Wednesday when and how it plans to raise interest rates to help tame the inflation that is straining household budgets.

Stock prices have fallen since the start of the year, in part in anticipation of higher Fed rates, which will make borrowing more expensive and potentially slow the economy and reduce corporate profits.

The Fed’s benchmark interest rate has been pegged close to zero since the pandemic broke out in March 2020 and triggered a recession. The Fed is expected to raise that rate in March by a quarter point to a range of 0.25% to 0.5%, and economists expect more rate increases later in the year.

To further tighten credit, the Fed also plans to end its monthly bond purchases in March. And later this year, it may start reducing its huge stock of Treasury and mortgage bonds. Taken together, these moves represent a dramatic reversal from the ultra-low interest rate policies imposed by the Federal Reserve during the pandemic recession.

The Fed’s moves are likely to make a wide range of borrowing — from mortgages and credit cards to auto loans and corporate credit — more expensive. These higher borrowing costs can, in turn, slow consumer spending. The most serious risk is that the Fed’s abandonment of low interest rates, which has buoyed the economy and financial markets for years, could trigger another recession.

Ahead of Wednesday’s updated policy statement from the Federal Reserve, the S&P 500 rose 1.6%. After closing at an all-time high on Jan. 3, the benchmark index is down 7.7%, close to a 10% decline that investors have described as a “correction.”

Economists say if the stock market is engulfed in more chaotic falls, the Fed may decide to delay some of its plans to tighten credit. However, the modest declines in share prices are not likely to affect its plans.

“The Fed doesn’t mind at all seeing risk repricing here but wants to see it in an orderly way,” said Elaine Jask, chief economist at PGIM Fixed Income, a global asset management firm.

Investors fear there may be more to come, which partly explains the extreme volatility in stock markets this week. Some on Wall Street are concerned that the Fed could signal an upcoming half-point increase in its key rate. There are also concerns that Powell, in his press conference, will suggest that the central bank will raise interest rates more often this year than most economists expect.

Another wild card – especially for Wall Street – is the Fed’s bond holdings. And as recently as September, those holdings were growing by $120 billion a month. The bond buying, which the Fed financed by creating money, was intended to lower long-term interest rates to stimulate borrowing and spending. Many investors saw bond purchases help fuel stock market gains by injecting liquidity into the financial system.

Earlier this month, minutes from the Federal Reserve’s December meeting revealed that the central bank was considering reducing its bond holdings by not replacing maturing bonds — a more aggressive move than simply ending purchases. Analysts now expect the Fed to start tightening its grip as early as July, much sooner than expected even a few months ago.

The effect of reducing the Fed’s bond stock is not well known. But the last time the Fed raised interest rates and lowered its balance sheet at the same time was in 2018. The S&P 500 stock index fell 20% in three months.

However, some analysts say they are not sure how big the impact will be on interest rates or how much the Fed will rely on reducing its balance sheet to affect interest rates.

“There is a fair amount of uncertainty about what to expect,” said Michael Hanson, global economist at JPMorgan Chase.

Powell will face a delicate and even risky balancing act in his press conference on Wednesday.

“It’s a stringy story,” Goldberg said. “They want to continue to sound hawkish – but not just so hawkish that they cause extreme market volatility.”

Some economists have expressed concern that the Fed is already acting too late to combat high inflation. Others say they worry that the Fed may act too aggressively. They argue that too many rate hikes would risk causing a recession and in no way slow inflation. From this point of view, higher rates often reflect congested supply chains that Fed rate hikes cannot handle.

This week’s Fed meeting comes against a backdrop not only of high inflation — consumer prices rose 7% last year, the fastest pace in nearly four decades — but also of an economy wracked by another wave of COVID-19 infections.

Powell admitted that he failed to anticipate that high inflation would continue, after he had long said he thought it would be temporary. The increase in inflation has widened beyond those affected by supply shortages – to apartment rents, for example – suggesting that it could continue even after goods and spare parts flowed more freely.

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