The Federal Reserve kept its benchmark federal funds rate at near-zero levels June 16, but most Fed officials now see at least one rate hike in 2023 and seven members see the central bank tightening as early as next year.
In its latest quarterly forecast, released June 16 following a two-day meeting, 13 of the 18 Federal Open Market Committee members expect at least one rate hike in 2023, up from just seven in the last forecast. Eleven of the 18 members now expect two rate hikes in 2023.
"We always knew the Fed would need to hike rates and they have to begin to introduce a roadmap," said John Davi, chief investment officer at Astoria Portfolio Advisors. "For me, today was the first of many steps the Fed will take in 2021 to prepare us for higher rates in 2022."
Shortly after the Fed's forecast was released, the S&P 500 fell by 0.7%; the benchmark U.S. Treasury 10-year yield, which moves inversely to prices, jumped from 1.49% to 1.58%; and the U.S. Dollar Index rose about 0.8%.
"The early market reaction showed that traders were caught off-guard by the hawkish shift in the Fed's interest rate projections," said Matt Weller, global head of market research with GAIN Capital.
During his press conference following the announcement, Fed Chairman Jerome Powell said there was no discussion of rate hikes during the FOMC meeting, calling the forecasts of members "not a great forecaster of future rate moves." Powell said the economy has taken great strides toward the central bank's inflation and labor goals but said the slowing pace of vaccinations and the possibility of other COVID-19 variants represented grave risks to the recovery.
"You're not out of the woods here," Powell said. "It's great to see the progress, but I would not declare victory yet."
No policy changes
In its post-meeting statement, the FOMC made no notable changes to its ultraloose, post-pandemic monetary policy, keeping the benchmark federal funds rate at effectively 0% and sticking with its plans to continue a $120 billion-per-month bond-buying program. As expected, the statement did not indicate that the Fed was planning to taper the monthly bond purchases, including $80 billion in Treasurys and $40 billion in mortgage-backed securities.
The minutes of April's meeting indicated that some participants pushed for a potential future discussion of tapering, and Powell said those discussions about the timing of future talks are underway.
Powell, in his press conference, repeated statements that policy changes will not take place until the central bank's inflation and employment goals are met, benchmarks Powell has kept intentionally vague to maximize flexibility. Powell did not indicate that any substantial discussion on tapering was underway since the economy was still "a ways away" from reaching inflation and employment goals.
"I expect that we'll have more to say about timing as we see more data," he said.
A recent runup in inflation, including a 5% increase from May 2020 to May 2021 in the Consumer Price Index — the largest year-over-year increase since 2008 — has fueled speculation that the Fed could tighten policy more quickly.
The New York Fed's June 14 Survey of Consumer Expectations showed that median year-ahead inflation expectations increased to 4% in May, up from
In its new forecast, the Fed now sees the Core Personal Consumption expenditure measure, its preferred measure of inflation, averaging 3% this year, up from its previous forecast of 2.2%. Fed officials have argued the inflation bump is transitory, but Powell said June 16 that inflation "could be higher and more persistent than we expect."
This rise in inflation has been countered by disappointing jobs data. The unemployment rate fell to 5.8% in May 2021, down from the high of 14.8% in April 2020 but still above the pre-pandemic rate of 3.5% in February 2020, according to the U.S. Bureau of Labor Statistics. Employment remains 7.6 million jobs below where it was before the pandemic.
In its latest forecast, the Fed pegs employment at 4.5% in 2021, the same forecast it had in March.
"If you look at the forecasts, we are going to be in a pretty strong labor market pretty quickly here," Powell said.
The Fed also forecast the change in real GDP to average 7% this year, up from its March forecast of 6.5%.