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The Fed is fed up with inflation and it's going to unwind its pandemic aid sooner than planned

Ben Winck   

The Fed is fed up with inflation and it's going to unwind its pandemic aid sooner than planned
  • The Fed said Wednesday it will double the pace for shrinking its emergency asset purchases.
  • "Inflation developments and the further improvement in the labor market" sparked the move, the Fed said.

Sky-high inflation has forced the Federal Reserve's hand.

The central bank announced Wednesday it will double the pace at which it shrinks its emergency asset purchases, tapering its buying of Treasurys by $20 billion each month, while its purchases of mortgage-backed securities will shrink by $10 billion monthly. In a Wednesday statement, it attributed this acceleration to "inflation developments and the further improvement in the labor market."

Starting in January, Treasury purchases will total at least $40 billion, while MBS buying will reach at least $20 billion. That's down from the pandemic highs of $80 billion and $40 billion, respectively.

"With elevated inflation pressures and a rapidly strengthening labor market, the economy no longer needs increasing amounts of policy support," Fed Chair Jerome Powell said in a Wednesday press conference.

The move marks a major shift as the Fed looks to balance its goals of reining in inflation while keeping the hiring recovery alive. The tapering of its asset purchases is its first step toward normalizing the unprecedented support it rolled out during the pandemic. The new pace suggests the Fed's asset purchases will end entirely in March instead of later in 2022.

Faster tapering paves the way for higher interest rates in 2022. The Fed's benchmark rate influences borrowing costs throughout the country from mortgage rates to car loans. The central bank slashed rates to record lows in March 2020 to pad the economy against the pandemic recession.

Now, with inflation running at historically high levels, the Wednesday statement suggests officials reverse its ultra-accommodative stance faster than previously expected. Data out on Friday showed year-over-year inflation hitting 6.8% in November, the highest level since 1982. Though Powell has maintained the surge will be transitory, faster tapering suggests the Fed will more aggressively fight inflation in 2022.

"The Fed apparently just woke up to the inflationary pressures consuming the US economy," Seema Shah, chief strategist at Principal Global Investors, said. "Price pressures may well ease next year, but inflation will settle at a level uncomfortably high for the Fed — this is transitory plus."

Economic projections published by the Fed on Wednesday signal officials will make three interest rate increases next year and another three in 2023. Median forecasts from Fed officials see the benchmark rate climbing to 0.9% in 2022 from 0.1%, and higher still to 1.6% in 2023.

Maximum employment is just a year away

Powell made clear in the afternoon press conference that the economy is making healthy progress toward hitting the Fed's target of maximum employment. With inflation running well above the Fed's target of averaging 2%, the employment goal remains the factor keeping the Fed from fully reversing its pandemic-era policy.

The country is "making rapid progress" toward the maximum employment target, Powell said, adding that all Federal Open Market Committee participants expect the criterion to be met in 2022.

The central bank's latest forecasts support the optimistic outlook. The unemployment rate is forecasted to drop to 3.5% and stay at the historically low level through 2024. That's an improvement from the September projection, which saw the rate only falling to 3.8% next year before hitting 3.5% in 2023.

At the same time, the labor shortage will make the employment recovery look different than those of the past, Powell said, adding that it's "unclear" how long the trend will last. Job openings rebounded close to record highs in October, while quits remained elevated. With nearly 7 million Americans still jobless, the trends hint businesses will struggle to attract workers well into 2022.

Labor force participation is slowly recovering, but a complete recovery might not happen "for some time," Powell said.

"The labor market is, by so many measures, hotter than it ever ran in the last expansion, if you think about it," he added.


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