Quarterly Update

Paul Single, Managing Director, Senior Economist, Senior Portfolio Manager | Jan. 2022

Fed Pivot Points to Higher Rates

The Fed has pivoted to a more hawkish approach to monetary policy

Interest rate increases may begin as early as March

The Fed is expected to hike the federal funds rate three times this year

At the Fed’s December meeting, they made a very hawkish pivot in their approach to monetary policy. The Fed is expected to increase interest rates as early as March, with at least three hikes expected this year. Back in September, the Fed was expecting just one interest rate hike of 25 basis points in 2022, and about half of the policymakers were not expecting to make any changes to the federal funds rate level.

The shift [in monetary policy] is a result of a focus on higher levels of inflation, which in the past few months has climbed to a level not seen since 1982. The Fed has two mandates: maximum employment and stable prices. The Fed has clearly met its goal of inflation slightly above 2.0%. As for employment, there are still 3.6 million fewer workers on payrolls compared to the month before the pandemic started. That said, there are also far fewer people looking for a job. Older workers (above 55) have retired early and left the workforce, and many younger mothers are not working due to a lack of affordable child care. So the Fed is now beginning to believe the economy may be close to maximum employment.

Another tool the Fed may utilize to slow the pace of inflation is reducing the size of its balance sheet. Since the early stages of the pandemic, the Fed has bought bonds to help push down intermediate- and longer-term interest rates. That program will end in March. If the Fed believes they need to slow the economy, they may begin selling some of those bonds, putting upward pressure on intermediate- and longer-term interest rates.

Moving from a dovish view on monetary policy to a hawkish one is always tricky, and the Fed does not want to make any mistakes in slowing the rate of economic growth. This year is even more challenging due to another COVID-19 variant surge that will cause business and consumer reactions. COVID-19 makes it difficult for the Fed to forecast the economy’s future accurately.

Key Points

The Fed has pivoted to a more hawkish approach to monetary policy

Interest rate increases may begin as early as March

The Fed is expected to hike the federal funds rate three times this year

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