Commentary: FOMC Decision
Yesterday, the Federal Reserve’s rate setting group, the Federal Open Market Committee, decided that it was time to face reality. Having been lampooned mercilessly for its consistent message that the high and rising rate of inflation was “transitory”, it decided to abandon the “don’t worry, be happy” message and changed course dramatically. Rate hikes are coming sooner and faster than expected, but they are needed and therefore welcomed.
Here are some of the key takeaways from the Fed’s statement, forecast and fed funds dot plot.
No more transitory: First, and most importantly, the term “transitory” was dropped. That was hardly a surprise, but it did set the stage for everything that came afterward. Instead, the Fed simply 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.” In other words, there was no attempt to forecast the length of time the economy could face elevated inflation, except to say that it will not come down until the pandemic eases and the supply chain problems dissipate.
Forget “tapering”; it’s now “vanishing”: The open-ended outlook for elevated inflation provides the Fed with the foundation needed to accelerate the ending of its asset purchase program. The “tapering” was accelerated and will now finish by March. That is important as it does two things: First, it sets the stage for an earlier increase in rates. You have to stop easing before you can start tightening. Second, it makes it clear that there is an urgency to the process. That is, inflation really is a concern.
Full employment is the trigger for rate hikes: Once the tapering is done, the Fed signaled it will start raising rates soon afterward. It set a target for when that would happen when it noted that “the Committee expects it will be appropriate to maintain this target range (0%-0.25%) until labor market conditions have reached levels consistent with the Committee’s assessments of maximum employment.”
With the unemployment rate currently at 4.2%, the FOMC may not have to wait long for the target of full employment to be met. Looking at the forecast, the Fed’s median longer-run forecast for unemployment (i.e., full employment) is 4.0%. That could be met sometime in the spring – and maybe sooner.
The tapering ends by March and full employment could be hit not long afterward. Consequently, the March 15-16, 2022 FOMC meeting looks like the earliest date the Fed might start tightening, with the May 3-4 meeting being the likely one, at least right now.
“Don’t go slow, just get it done”: Maybe the most startling part of the message sent was that the Fed may not raise rates as slowly as expected. The Economic Projections Table indicated that as many as three rates hike could occur in 2022. That is really nothing excessive. Indeed, the forecast now suggests there would be another 100 basis points in both 2023 and 2024. Three years to get back to long-term rate levels is hardly breakneck speed.
Summary: The economy is growing solidly, job and wage gains are strong, the unemployment rate is nearing full employment, but inflation is high and showing minimal signs of decelerating rapidly. This environment calls not just for the ending of monetary stimulus, but a tightening of policy so it gets back to something closer to neutral. That is what the Fed said yesterday, and it should be good news for the markets and the longer-run health of the economy.
(Next FOMC meeting: January 25-26, 2022)