Fed Prepares Faster End to Stimulus, Making Earlier Rate Increases Possible

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The move to end the stimulus program sooner than officials planned at their meeting last month offers the most concrete sign of how Fed Chairman

Jerome Powell’s

focus is shifting toward preventing higher inflation from becoming entrenched and away from fostering a rapid rebound in hiring.

The Fed will release its postmeeting policy statement at 2 p.m. Eastern time, along with new economic and interest-rate projections. Mr. Powell will follow with a news conference at 2:30 p.m., when he is likely to face questions over what the Fed’s latest decisions say about the path for interest rates in 2022.

Here’s what to watch:

Faster runoff

Mr. Powell and his colleagues have strongly signaled they might reduce the Fed’s purchases of Treasurys and mortgage-backed securities more quickly than they planned at their Nov. 2-3 meeting. They approved plans then to shrink the then-$120-billion-a-month bond purchases by $15 billion a month in November and December.

Since then, officials have been surprised by a run of hotter economic data, including a substantial drop in the unemployment rate, strong consumer spending, a rise in inflation and a broadening of price pressures.

Officials could quicken the pace at which they reduce the purchases by $30 billion a month beginning in January, which would conclude the program by March. Alternately, they could end the program by February if they were to reduce purchases by $35 billion a month between now and then.

Rate projections

Mr. Powell has repeatedly emphasized this year that the Fed has a different and more stringent test for raising interest rates than it does for ending asset purchases. But that distinction will be very blurry if the Fed accelerates the wind-down of the bond buying. Officials would be ending the program sooner so they could begin raising interest rates sooner. The Fed wants to end the asset purchases before it lifts its short-term benchmark rate from near zero.

Federal Reserve Chairman Jerome Powell discussed in a Senate hearing the factors driving continued inflation and the risk the Omicron variant poses for the economy. Photo: Al Drago/Bloomberg News

New interest-rate projections are likely to show most Fed officials expect they will need to raise rates more than once next year. That would be a substantial revision from projections in September, when officials were roughly divided over whether an interest-rate increase would be needed in 2022 versus 2023.

The projections will also show the path they see for rate increases beyond next year, including how quickly they believe rates need to return to a neutral setting designed to neither spur nor slow growth.

Economic predictions

Officials will also update their economic projections, because unemployment has fallen lower and inflation has climbed higher than they expected in September. The unemployment rate stood at 4.2% in November, a full percentage point lower than it was in August, the most recent figure available when officials completed their September projections.

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A significant focus of the new projections will be on where officials see annual inflation by the end of next year. In September, they projected core inflation, which excludes volatile food and energy categories, would fall to 2.3% at the end of next year, using the Fed’s preferred gauge. In October, core consumer prices were up 4.1% over the previous 12 months.

In his news conference, Mr. Powell could provide more color on how officials regard the prospects for underlying inflation to unfold next year—that is, increases in prices even if officials are right that prices for certain imported goods will decline around the middle of next year as supply-chain bottlenecks abate. Housing and rental costs have been accelerating, and together with wage growth could contribute to more durable price pressures that might give Fed officials greater conviction to raise interest rates.

The policy statement

Mr. Powell has suggested the central bank is likely to stop referring to inflation as “transitory,” owing partly to confusion over what the term means and partly to signal greater humility around forecasts given the magnitude of the surge in prices this year.

The Fed’s policy statement might further be overhauled in ways that provide additional guidance around how close officials believe they are to meeting two tests they laid out last year before they would raise interest rates. First, officials said they wanted to be sure inflation wouldn’t drop below 2%. While many officials say they have met that test, they haven’t said this yet in their statement.

Second, they want labor-market conditions to be consistent with maximum employment. Officials aren’t likely to define this condition numerically, but they could provide in the statement or in Mr. Powell’s news conference more information about how they are judging progress.

While there are still 3.9 million fewer people working than in February 2020, some of that gap might reflect retirees or others who are choosing not to work for several reasons, including fear of Covid-19, increased household wealth or lack of child care. It isn’t known how many people have left the labor force for good.

Write to Nick Timiraos at [email protected]

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