The Fed will actively reduce monthly bond purchases and is expected to raise interest rates three times next year

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The Fed provided a number of signs on Wednesday that its ultra-loose policy since the beginning of the new crown virus pandemic is about to end, and its actions are even more radical than market expectations.

On the one hand, the Fed said it will accelerate the pace of reducing monthly debt purchases.

Beginning in January, the Fed will purchase $60 billion in bonds each month, half of the level before the scale reduction in November, and $30 billion less than the bonds purchased in December. The Fed cut 15 billion U.S. dollars a month in November, twice the rate in December, and will further accelerate the reduction in 2022.

After that, probably around March, the central bank is expected to start raising interest rates, and interest rates will remain stable at this week’s meeting.

Forecasts released on Wednesday indicated that Fed officials expect to raise interest rates as many as three times in 2022, two in the second year, and two more in 2024.

The unanimous Federal Open Market Committee’s move is a major adjustment to the loosest policy in its 108-year history. The statement after the meeting pointed out the impact of inflation.

The statement said: “The imbalance between supply and demand related to the pandemic and economic reopening continues to lead to higher levels of inflation.”

The statement also pointed out that “employment growth has been steady in recent months, and the unemployment rate
The rate has dropped significantly. “

Both of these policy measures are in response to escalating inflation, which is at its highest level in 39 years. Wholesale prices rose by 9.6% in November, the fastest increase on record, indicating that inflationary pressures are becoming more entrenched and widespread.

Fed officials have long emphasized that inflation is “temporary,” and Chairman Jerome Powell defined it as unlikely to have a lasting impact on the economy. He and other central bank leaders, as well as Treasury Secretary Janet Yellen (Janet Yellen) emphasized that prices are rising due to factors related to the pandemic, such as abnormal demand that exceeds supply but will eventually fade.

However, the term has become a derogatory term and it will be deleted after the meeting. Powell expressed this move in testimony to Congress last month, saying that “now may be a good time to drop the term and try to explain more clearly what we mean.”

For the Fed Powell, the tightening policy now marks a dramatic change in the policy issued more than a year ago. It is called a “flexible average inflation target”, which means that it will be satisfied with inflation slightly above or below its long-term 2% target.

The practical application of this policy is that in order to completely heal the labor market from the blows suffered during the pandemic, the Fed is willing to allow inflation to rise slightly. The Fed’s new policy seeks full and inclusive employment across race, gender, and economic boundaries. Officials agreed not to raise interest rates in anticipation of rising inflation as the central bank has done in the past.

However, as the “temporary” narrative was questioned and inflation began to look stronger and more durable, the Fed had to reconsider its intentions and change gears.

The reduction in asset purchases began in November, reducing US$10 billion in Treasury bond purchases and US$5 billion in mortgage-backed securities. This still brings this month’s purchases to 70 billion U.S. dollars and 35 billion U.S. dollars, respectively.

However, the Fed’s US$8.7 trillion balance sheet has only increased by US$2 billion in the past four weeks, of which US Treasury holdings have increased by US$52, while MBS has actually decreased by US$23 billion. In the past 12 months, holdings of US Treasury bonds have increased by US$977.8 billion, while holdings of MBS have increased by US$567 billion.

According to the new terms of the quantitative easing program, the Fed will accelerate the reduction of its holdings until it no longer increases its investment portfolio. This will bring quantitative easing to an end in the spring and allow the Fed to raise interest rates at any time thereafter. The Fed has said that it may not raise interest rates and continue to buy bonds at the same time, because these two measures will cross each other.

From then on, the Fed can begin to shrink its balance sheet at any time by directly selling securities, or, if more likely, it can begin to allow its current bond earnings to drain at a controlled rate every month.

Powell may face questions about the future of the balance sheet at a press conference at 2:30 pm Eastern time, which has expanded by nearly $3.9 trillion since the beginning of the pandemic.

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