The Fed is expected to take a very big step towards raising interest rates for the first time

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Federal Reserve Chairman Jerome Powell attends the House of Representatives Financial Services Committee hearing on September 30, 2021, on Capitol Hill in Washington, USA.

Aldrago | Reuters

The Fed is expected to announce a major policy change on Wednesday, clearing the way for the first interest rate hike next year.

The market expects the Fed to speed up the end time of its bond purchase program, changing the end date from June to March.

This will enable the central bank to raise interest rates from scratch, and Fed officials are expected to issue new forecasts showing that interest rates will be raised two to three times in 2022 and another three to four times in 2023. Raise interest rates in 2022, although half of Fed officials expect to raise interest rates at least once.

At the end of the two-day meeting on Wednesday afternoon, the central bank should also acknowledge that inflation is no longer a “temporary” or temporary problem that officials considered, and that rising prices may pose a greater threat to the economy. The consumer price index rose by 6.8% in November, and December may be hot again.

Rick Rieder, BlackRock’s global fixed income chief investment officer, said: “I think it’s too late to exit the easing policy.”

The Federal Reserve implemented a quantitative easing program in early 2020 in response to the impact of the pandemic and lowered its target federal funds interest rate to zero.

Prepare the market

Fed officials began discussing the idea of ​​a more rapid reduction in mid-November. They successfully changed market expectations in order to seek a faster end to the $120 billion monthly one-off bond purchase program. The market’s expectations for the timing of interest rate hikes from the end of next year to June have also advanced.

Reid said that by ending bond purchases early, the Fed gave itself the option to raise interest rates. “I think they can raise interest rates in 2022. I don’t think they will rush for success,” Reid said.

He stated that the Fed may raise interest rates twice in 2022 and three to four times in 2023.

“I think the data will determine when they start. I don’t think the Fed has any idea that they must start in any particular quarter,” he said. Reid said that by then the Fed will be able to better deal with the persistence of inflation and whether the virus will continue to be a risk to the global economy in the new year.

Although the Fed is expected to sound tough or in tightening mode, Fed Chairman Jerome Powell sounded like he might want to speak to the media at 2:30 pm Eastern Time on Wednesday, 30 minutes after the central bank’s statement and forecast. Much less.

Vince Reinhart, chief economist at Dreyfus & Mellon, said: “In order for them to justify accelerating downsizing, the Federal Open Market Committee’s statement must be very sudden.” Powell may discuss rising inflation, And why the Fed will remain cautious.

Reinhardt said: “We withdrew from the’short-lived’, but the transition seems to be important because he made a rapid transition.” “He can spend some time talking about virus mutations, prospective risks, and things that might go wrong.”

Wildcard balance sheet

For the market, the biggest uncertainty is the Fed’s view of its balance sheet, which was $4.1 trillion in January 2020 before the pandemic, but has now swelled to $8.7 trillion. As the securities on the balance sheet mature, the Fed will replace them, thereby individually buying billions of dollars in US Treasury bonds each month.

Reid said: “If he stands up and says we don’t need to keep the scale at these levels, it will surprise the market.” He said that the Fed is more likely to shrink its balance sheet after raising interest rates.

But he said that the Fed’s final reduction of its balance sheet may sometimes have a greater impact on the market than raising interest rates.

Goldman Sachs economists developed a scenario for this runoff. They said that the scenario may be less conservative than the last cycle after the financial crisis. If the Fed allows securities to mature simply and does not replace them, the balance sheet will begin to shrink and runoff will begin.

“We predict that the fourth rate hike will come in the first half of 2023, so our best guess right now is that runoff will begin at that time. Research on balance sheet policies shows that runoff has an impact on interest rates and broader financial conditions. , Growth, and inflation should be moderate, well below our expected rate hike,” they wrote in a report. “However, the market sometimes reacts strongly to the reduction in past balance sheets.”

Grant Thornton chief economist Diane Swonk (Diane Swonk) expects the Fed to discuss the balance sheet at this meeting, but will not take action.

“I think he will be questioned about the balance sheet,” Swank said. “They did try to drain their balance sheet before. This is what we should expect to happen sooner this time. I don’t think they have made that decision yet…I won’t be surprised. [meeting] minute. “


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