Fed maintains rate but to end QE and raise rate ‘soon’

January 26, 2022

The U.S. Federal Reserve left its key interest rate unchanged but said “with inflation well above 2 percent and a strong labor market, the Committee (the Fed’s policy-making body) expects it will soon be appropriate to raise the target range for the federal funds rate,” a message financial markets expected.
The Federal Open Market Committee (FOMC) also said it had decided to “reduce the monthly pace of its net asset purchases, bringing them an an end in early March,” with a reduction in the size of its balance sheet to begin after the benchmark federal funds rate has been raised.
The Fed kept its target for the federal funds at 0.0 to 0.25 percent, unchanged since March 2020 when the rate was lowered twice in a single month by a total of 1.50 percentage points.

Today’s statement continues the Fed’s pivot toward monetary tightening after the policy stance was kept ultra easy for five quarters while economic activity gradually recovered from the devastating hit from the COVID-19 pandemic and inflation rose.

In November 2021 the Fed finally joined the global trend toward monetary tightening – central banks raised rates 124 times last year to combat rising inflation – and trimmed its monthly purchases of Treasury securities and mortgage-backed securities.

In December last year the Fed then sped up the pace of monetary tightening further by trimming asset purchases even more and dropped its description of inflation as “transitory” as it raised its forecast for inflation and projected three rate hikes of 25 basis points each in 2022 and another three in 2023.

With inflation continuing to rise – headline inflation hit 7 percent in December, the highest since June 1982 from 6.8 percent – Fed Chairman Jerome Powell this month kept up his hawkish message, describing inflation as a “severe threat” to a Senate hearing on Jan. 11, boosting market expectations the Fed may even raise rates four times this year.

Today marks another critical step forward in the normalization of global monetary policy and follows on the heels of the Bank of Canada’s message earlier today that interest rates need to be raised.

As in December, the Fed said economic activity and employment have continued to improve though there are still risks to the outlook from new variants of the virus, such as the Omicron variant.

However, the Fed also acknowledged inflation is “well above” its 2 percent target and the labor market was strong, the two conditions it had laid out in order to tighten monetary policy.

To wrap up its asset purchases – known as Quantitative Easing (QE) and used as an addition tool to ease policy – the Fed said it would purchase at least $20 billion of Treasury securities at least $10 billion of agency mortgage-backed securities in February to continue to smooth market functioning and support the flow of credit.

However, next month will be the final month of asset purchases that will end in early March.

The Fed said a reduction of its balance sheet – which contains some $8.8 trillion of bonds and securities – “will commence after the process of increasing the target range for the federal funds rate has begun.”

The Board of Governors of the Federal Reserve System issued the following two statements by the Federal Open Market Committee:

“Indicators of economic activity and employment have continued to strengthen. The sectors most adversely affected by the pandemic have improved in recent months but are being affected by the recent sharp rise in COVID-19 cases. Job gains have been solid in recent months, and the unemployment rate has declined substantially. Supply and demand imbalances related to the pandemic and the reopening of the economy have continued to contribute to elevated levels of inflation. Overall financial conditions remain accommodative, in part reflecting policy measures to support the economy and the flow of credit to U.S. households and businesses.

The path of the economy continues to depend on the course of the virus. Progress on vaccinations and an easing of supply constraints are expected to support continued gains in economic activity and employment as well as a reduction in inflation. Risks to the economic outlook remain, including from new variants of the virus.

The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. In support of these goals, the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent. With inflation well above 2 percent and a strong labor market, the Committee expects it will soon be appropriate to raise the target range for the federal funds rate. The Committee decided to continue to reduce the monthly pace of its net asset purchases, bringing them to an end in early March. Beginning in February, the Committee will increase its holdings of Treasury securities by at least $20 billion per month and of agency mortgage‑backed securities by at least $10 billion per month. The Federal Reserve’s ongoing purchases and holdings of securities will continue to foster smooth market functioning and accommodative financial conditions, thereby supporting the flow of credit to households and businesses.

In assessing the appropriate stance of monetary policy, the Committee will continue to monitor the implications of incoming information for the economic outlook. The Committee would be prepared to adjust the stance of monetary policy as appropriate if risks emerge that could impede the attainment of the Committee’s goals. The Committee’s assessments will take into account a wide range of information, including readings on public health, labor market conditions, inflation pressures and inflation expectations, and financial and international developments.

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Voting for the monetary policy action were Jerome H. Powell, Chair; John C. Williams, Vice Chair; Michelle W. Bowman; Lael Brainard; James Bullard; Esther L. George; Patrick Harker; Loretta J. Mester; and Christopher J. Waller. Patrick Harker voted as an alternate member at this meeting.”

Principles for Reducing the Size of the Federal Reserve’s Balance Sheet

“The Federal Open Market Committee agreed that it is appropriate at this time to provide information regarding its planned approach for significantly reducing the size of the Federal Reserve’s balance sheet. All participants agreed on the following elements:

The Committee views changes in the target range for the federal funds rate as its primary means of adjusting the stance of monetary policy.
The Committee will determine the timing and pace of reducing the size of the Federal Reserve’s balance sheet so as to promote its maximum employment and price stability goals. The Committee expects that reducing the size of the Federal Reserve’s balance sheet will commence after the process of increasing the target range for the federal funds rate has begun.
The Committee intends to reduce the Federal Reserve’s securities holdings over time in a predictable manner primarily by adjusting the amounts reinvested of principal payments received from securities held in the System Open Market Account (SOMA).
Over time, the Committee intends to maintain securities holdings in amounts needed to implement monetary policy efficiently and effectively in its ample reserves regime.
In the longer run, the Committee intends to hold primarily Treasury securities in the SOMA, thereby minimizing the effect of Federal Reserve holdings on the allocation of credit across sectors of the economy.
The Committee is prepared to adjust any of the details of its approach to reducing the size of the balance sheet in light of economic and financial developments.”

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