The Federal Reserve took its first step towards withdrawing support for the U.S. economy on Wednesday, saying it would begin to end a stimulus package that has been in place since the start of the pandemic as the economy recovers and that prices are climbing at an uncomfortably fast rate.
Central bank policymakers took a slightly more suspicious tone about inflation, which has surged this year amid strong consumer demand for goods and supply grunts. While officials still expect rapid cost increases to fade, it is unclear how quickly this will happen.
Fed officials want to be prepared for any outcome at a time when the economic trajectory is marked by serious uncertainty. They don’t know when prices will start to calm down, to what extent the labor market will recoup the millions of jobs still missing after last year’s economic slump, or when they will start raising interest rates – which stay low to keep borrowing and spending cheap and easy.
So the central bank’s decision to scale back its other policy tool, large-scale bond purchases that allow money to flow through financial markets, was intended to give the Fed the flexibility it might need to react to a changing situation. Officials on Wednesday presented a plan to slow their monthly purchases of $ 120 billion of Treasury bonds and $ 15 billion per month mortgage-backed securities from November. Purchases can lower long-term interest rates and induce investors to invest that would stimulate growth.
Assuming that this pace continues, bond buying would come to a complete halt when the central bank meets next June – potentially putting the Fed in a position to hike interest rates by the middle of. next year.
The Fed is yet to say that rate hikes, a powerful tool that can quickly slow demand and offset inflation, is imminent. Policymakers would prefer to leave them low for a while to allow the labor market to recover as much as possible.
But the decision announced on Wednesday will leave them more agile to react if inflation remains sharply high until 2022 instead of starting to moderate. Many officials would not want to raise interest rates while they are still buying bonds, as that would mean that one tool is fueling the economy while the other is slowing it down.
“We think we can be patient,” Fed Chairman Jerome H. Powell said of the way forward on interest rates. “If an answer is required, we will not hesitate.
Congress gave the Fed two tasks: to achieve and maintain stable prices and as many jobs as possible.
These are delicate tasks in 2021. Twenty months after the start of the global coronavirus pandemic, inflation has skyrocketed, with prices climbing 4.4% in the year through September. That’s well above the 2% price gains the Fed is aiming for on average over time.
At the same time, far fewer people are working than before the pandemic. About five million jobs are missing from February 2020. But this deficit is difficult to interpret, as businesses across the country struggle to fill vacancies and wages are rising rapidly, characteristic of a labor market. solid.
For now, the Fed is betting that inflation will subside and the labor market will attract workers, who could be left on the sidelines to avoid catching the coronavirus or because they have custody issues. children or other issues that keep them at home.
“There is room for a lot of humility here,” said Powell, explaining that it was difficult to gauge how quickly the employment rate could recover. “It’s a complicated situation.
Officials have already been surprised this year by the extent of inflation and the duration of this pop. They expected prices to rise as the cost of dining and air travel rebounded from the lows of the pandemic, but the severity of supply chain disruptions and continued strength in consumer demand surprised Fed officials and many economists. .
In their November policy statement, Fed officials predicted that this inflation surge would subside, but they dampened their confidence in it. They previously said the factors driving high inflation were transient, but they updated that language on Wednesday to say the drivers were “should be”Transient, recognizing growing uncertainty.
“Supply and demand imbalances linked to the pandemic and the reopening of the economy have contributed to significant price increases in certain sectors,” the statement added.
The Fed is prepared to tolerate a temporary bout of rapid inflation as the economy reopens after the pandemic, but if consumers and businesses come to expect consistently higher prices, it could cause problems. Persistent high and erratic inflation would make planning difficult for companies and could eat away at wage increases for workers without bargaining power.
“We need to be aware of the risks – especially now the risk of significantly higher inflation,” Mr. Powell said. “And we need to be able to deal with that risk if it creates a more persistent and longer-term threat of inflation.”
Understanding the supply chain crisis
Investors were well prepared for Wednesday’s announcement and took the news of the slowdown in bond buying. The S&P 500 rose 0.7% at the end of the session, hitting a new high.
This is noticeable because of the tumultuous market reaction in 2013, when the Fed hinted that it would soon end a similar program that had been put in place in response to the financial crisis. A repeat of what has been called ‘taper tantrum’ in financial markets appears to have been avoided thanks to the Fed’s ginger communication in recent months.
Mr Powell said the Fed would be “very transparent” if it decided to speed up or slow the pace of its liquidation of bond purchases, noting that it did not want to surprise the markets.
“They give themselves as much flexibility as possible,” said Seema Shah, chief strategist at Principal Global Investors, of Wednesday’s Fed statements. “In all fairness, it’s a really uncertain environment, isn’t it? And there are things happening that are stimulating the economy that are really beyond the Fed’s control. So they can only try to be reactive.
Officials have tried to separate their slower bond buying path from their interest rate plans. But investors increasingly expect rate hikes to start midway through 2022.
The Fed has said it wants to achieve full employment before raising borrowing costs to cool the economy, and Mr Powell has made it clear that the labor market has yet to reach that stage. He said it is possible, but not certain, that he will be able to reach the maximum number of jobs next year.
If the Fed has to raise interest rates to contain inflation before the labor market heals, it could come at a considerable cost. While some employees may have retired since the start of the pandemic, many people who are now being sidelined are in their prime of working years. They may start looking for a job again as childcare issues are resolved and health issues decrease.
If the Fed slows the economy down before they can, it might be more difficult for these workers to access new jobs, leaving the economy with less potential and families with fewer paychecks.
“We are accountable to Congress and the American people for maximum employment and price stability,” said Powell, noting that the pace of inflation right now is not consistent with stability prices, but that the economy is not at the peak of employment either.
He called the Fed’s position a “risk management” approach.
“He acknowledged that there was a lot of uncertainty around the outlook right now,” said Laura Rosner-Warburton, senior economist at MacroPolicy Perspectives. “The policy must be flexible. “
Matt phillipscontributed reports.