The Federal Reserve is expected to signal its first interest rate hike in three years during a pivotal two-day meeting this week, opening the door to a March liftoff as policymakers seek to combat the hottest inflation in four decades.
There is broad support among central bank officials to begin aggressively normalizing policy amid growing concern over the rapid increase in consumer prices, which surged 7% in December, the Labor Department said earlier this month. It marked the fastest pace for inflation since 1982 as consumer demand confronts a shortage of goods caused by congested ports and other pandemic-induced disruptions in the supply chain.
The Fed began tapering its bond purchases in November by $15 billion a month, and announced during its December meeting that it would double that to $30 billion beginning in January. Under that timeframe, the central bank is poised to conclude the program by March, allowing Fed officials to begin hiking interest rates and reducing the $8.8 trillion balance sheet.
"It is really time for us to move away from those emergency pandemic settings to a more normal level," Chairman Jerome Powell said earlier this month while testifying before the Senate Banking Committee. "It’s a long road to normal from where we are."
Most economists expect the Fed to raise rates four times this year.
Economic projections from the Fed's December meeting show that officials expect rates to stand at 0.9% at the end of 2022, 1.6% at the end of 2023 and 2.1% at the end of 2024. Traders are already pricing in a more than 90 % chance of a rate increase during the Fed's mid-March meeting, and a roughly 65% chance of four hikes over the course of the year, according to the CME Group, which tracks trading.
"The policy objective at Wednesday’s meeting will be to prepare market participants for the major shift in policy that lies ahead: a rate hike in March, another in June, and a balance sheet runoff likely to start in June or July," said Joe Brusuelas, RSM chief economist.
Some economists believe the Fed waited too long to confront the burst in inflation, while others have expressed concerns that moving too quickly to stabilize prices risks slowing hiring and potentially leaving many workers, particularly lower-income Americans, without a job. Hiking interest rates tends to create higher rates on consumers and business loans, which slows the economy by forcing employers to cut back on spending.
"The hawkish tone of the FOMC minutes suggests that the central bank is concerned about inflation, but a removal of Fed stimulus may not be enough to calm inflation, which is largely being caused by supply chain disruptions, something the Fed can’t control," Nancy Davis, founder of Quadratic Capital Management, said.
The Fed meeting will also take place in the shadow of an extremely volatile week for the stock market, with the Dow Jones Industrial Average on Monday plunging more than 1,000 points to its lowest level in 10 months before clawing its way back.
Powell will brief the media during an hour-long press conference following the FOMC decision, which will be released on Wednesday at 2 p.m. ET.