Fed poised to begin rate hikes in March

The Federal Reserve held its target interest rate steady in the 0% to 0.25% range at its first meeting for 2022 in January. However, the Federal Open Market Committee, the Fed’s rate-setting body, indicated in a statement that “it will soon be appropriate to raise the target range for the federal funds rate.”

This comes against a backdrop of rising inflation, which had risen 7% over the year last December, per the Consumer Price Index – reportedly its biggest jump in 40 years.

With the Fed looking to tighten its monetary policy this year, and the market anticipating three rate hikes, credit cardholders can anticipate an increase in the interest rates they pay. Variable credit card APRs are tied to the prime rate, which in turn is based on the Fed’s target interest rate. In preparation for this move, now would be a good time to take advantage of low rates and clean up your financial house.

The Fed will also reduce the pace of its purchases of mortgage-backed securities and Treasuries, with the intent of ending these purchases by March.

In its assessment of the economic situation, the FOMC noted that while the recent rise in COVID cases due to the Omicron variant of the virus has had a negative impact, the unemployment rate has declined “substantially” and the job market is strong. However, inflation is running high due to supply and demand imbalances arising from the pandemic and the reopening of the economy.

Fed set to hike rates

In a related press conference following the FOMC meeting, Fed Chair Jerome Powell noted that the economy no longer needs the Fed’s easy money policy. However, in terms of the exact details of interest rate hikes, he can’t predict with much confidence the details of policy. Rather, the Fed will have to be “humble and nimble” and “led by the incoming data and evolving outlook.”

The FOMC will be weighing whether to raise its target rates at its March meeting, and the committee is “inclined that way,” according to Powell. After that, the Fed will turn its attention to reducing the size of its balance sheet asset holdings in subsequent meetings. He expects the underlying strength of the economy will come through once the Omicron hit is over.

The Fed is attentive to the risk that inflation will be higher than expected, driving it to act to contain the possibility of “entrenched” inflation. Powell expects inflation to decline over the course of the year, but acknowledged that it has persisted for longer than the Fed expected.

Inflation is especially hard on those who live on a fixed or limited income. They must make difficult decisions, choosing between necessities, if prices continue to rise. And it could also pose a threat to a rise in labor participation.

However, the labor market and economy are also in a strong position and will be able to weather rate hikes. In fact, employment may even go up as labor participation improves since participation has been impacted by the COVID situation.

Thus, “both sides of the mandate are calling for us to move steadily away” from the Fed’s current accommodative stance, Powell said, referring to the inflation and employment situation, so as to foster price stability.

This expansion is different from any other in the past, with higher inflation and growth as well as a stronger labor market. The Fed will take that into account as it makes interest rate decisions this year.

Did accommodative policy foster inflation?

The last economic cycle was a long one and it could have gone on indefinitely had it not been for the impact of COVID, according to Powell, and the U.S needs another long cycle this time around.

The risks from COVID are not over yet, and the virus could slow down growth as it continues to evolve. There could also be a slowdown in the supply chain as China implements its “no COVID” policy. Powell expects the supply chain issues to be worked out by the end of the year, though.

As for the question of whether the Fed was too accommodative to combat the COVID threat, thereby stoking inflation, Powell noted, “It’s too soon to write that history.” He pointed out that there was a real risk of great damage at the beginning of the pandemic in early 2020, with the global economy shutting down. Both Congress and the Fed responded rapidly to that threat of economic collapse.

Thanks to such action, the U.S. economy is now the strongest in the world, and this recovery is unlike any previous one. “It (the stimulus) was all founded on a very strong reaction to a unique historical event,” Powell said.

He also doesn’t see any risk from high asset prices, noting that “overall financial stability vulnerabilities are manageable.”