Fed raises rates and projects six more increases in 2022. (Published 2022) (2024)

Fed raises rates and projects six more increases in 2022.

Mr. Powell said that, in his view, “the probability of a recession within the next year is not particularly elevated,” and that “all signs are that this is a strong economy and, indeed, one that will be able to flourish” with less policy help.

“The economy, we think, can handle interest rate increases,” he said.

In spite of the forecast for higher rates, stocks rose 2.2 percent on Wednesday, a possible signal that investors took heart in Mr. Powell’s insistence that the economy was strong enough to withstand the bank’s efforts to slow inflation.

The Fed’s decision to raise rates was an inflection point after two years of trying to help the economy recover from the damage inflicted by the pandemic. While the coronavirus continues to disrupt commerce around the world, the U.S. economy has recovered swiftly. America’s job market has rebounded rapidly from steep pandemic job losses, and businesses are now struggling to find workers.

A surge in consumer spending has helped to push the rate of inflation to levels not seen since the 1980s. Instead of echoing the anemic slog back from the 2007-9 recession — one that kept millions of applicants out of work and left inflation tepid despite years of rock-bottom rates — the pandemic bounce-back has been vigorous.

Judging by inflation, it may even have too much heat, which is why the Fed is trying to cool it to a more sustainable pace.

“We’ve had price stability for a very long time, and maybe come to take it for granted — but now we see the pain,” Mr. Powell said. “We’re strongly committed, as a committee, to not allowing this higher inflation to become entrenched, and to use our tools to bring inflation back down to more normal levels.”

Central bankers have plotted a more aggressive plan for controlling inflation than in December, when they last released economic projections. Officials now expect to raise rates to 2.8 percent by the end of 2023, based on the median estimate, up from 1.6 percent in their previous projections. That is high enough that, by the Fed’s own estimates, it might amount to actually tapping the brakes on the economy — not just taking a foot off the gas pedal.

“They knew their policy didn’t match the economic backdrop, and this is catch-up,” said Priya Misra, the head of global rates strategy at TD Securities.

Higher interest rates will trickle out through the markets to make mortgages, car loans and borrowing by businesses more expensive. That is expected to slow consumption and investment, reducing demand in the economy and — Fed officials hope — eventually weighing down surging prices.

Given the path ahead for interest rate increases and the way they filter through the economy, some economists said the central bank’s forecasts for strong growth and a very low unemployment rate this year and next might be optimistic.

“It’s a bit of a magical, immaculate disinflation,” said Michael Feroli, chief U.S. economist at J.P. Morgan. “Even if they’re not saying it or showing it in their forecasts, at some point you do need to slow the economy.”

Mr. Powell noted on Wednesday that inflation was “well above” the Fed’s target and that supply chain disruptions had been larger and longer lasting than officials expected. Now price increases are broadening to rent and other services, and high gas prices could keep costs elevated, he noted.

The Fed’s quarterly economic projections, released alongside the rate decision, showed that officials expected inflation to be 4.3 percent by the end of 2022. While that is less than the 6.1 percent increase in the 12 months through January, it is more than double the Fed’s goal of 2 percent.

The Fed aims for maximum employment in addition to price stability, and many signs suggest it is achieving that goal. Unemployment has dropped sharply, job openings are plentiful, and there are too few workers to go around. A booming job market has helped to push wage growth higher as employers compete for workers and try to retain employees by paying more.

But that, too, could risk fueling inflation. Higher pay gives workers more to spend, and it leaves companies trying to cover climbing labor costs. From a price stability standpoint, Mr. Powell said, recent wage growth has not been sustainable.

There is a “misalignment of demand and supply, particularly in the labor market, and that is leading to wages moving up in ways that are not consistent with 2 percent inflation over time,” he said.

As signs of bubbling price pressures abound, some Fed officials have become nervous. James Bullard, the president of the Federal Reserve Bank of St. Louis, voted against the committee’s decision because he favored a larger interest rate increase of half a percentage point.

Mr. Bullard and some other Fed officials have argued that moving rates up more quickly at first would show that the central bank was prepared to beat back rapid price increases.

But Mr. Powell made clear on Wednesday that, even if it is raising rates steadily instead of adjusting them briskly at first, the Fed’s policy committee knows it needs to act to restore price stability.

“We’re not going to let high inflation become entrenched,” Mr. Powell said.

The Fed is changing policy at a fragile moment. Russia’s invasion of Ukraine has raised obstacles to steady economic growth around the world, even as it has sent oil and gas prices higher and threatened to perpetuate tangled supply chains and high inflation.

“The implications for the U.S. economy are highly uncertain,” the Federal Open Market Committee said in its statement Wednesday. “But in the near term the invasion and related events are likely to create additional upward pressure on inflation and weigh on economic activity.”

The central bank does not want to stoke uncertainty at a geopolitically fraught moment, and Mr. Powell went out of his way to lay out its plans clearly. While he did not commit to a quarter-point rate increase at each meeting, he noted that many officials expect the same number of rate moves as there are meetings left in 2022, including this week's — a total of seven.

Markets are also carefully watching to see when the Fed will begin to shrink its nearly $9 trillion balance sheet of bond holdings, a policy move that could push up longer-term interest rates. Mr. Powell made clear that a plan could come as soon as the Fed’s May meeting and that it will look much like the one the bank used when it shrank its balance sheet from 2017 to 2019, albeit sooner and faster.

As the Fed acts to control inflation, the impact is likely to be palpable. Mortgage rates have already climbed as the central bank has signaled its coming policy changes.

Steeper borrowing costs are likely to weigh on hiring, to slow wage growth and to keep asset prices — including those for stocks and homes — from rising as much as they draw buyers and investors away.

A recession is a possibility any time the Fed raises interest rates, but allowing inflation to rise unchecked could also be a risk. Already, retail sales data on Wednesday offered an early hint that higher prices may be making it harder for some consumers to afford things. Households are sitting on big savings amassed during the pandemic, which could help them to sustain spending in the months ahead, but rapid price increases could eventually eat into those stockpiles.

“High inflation takes a toll on everyone, but really, especially, on people who use most of their income to buy essentials like food, housing, and transportation,” Mr. Powell said.

Economists have said a repeat of the painful early 1980s, when the Fed caused a deep recession as it battled inflation, is unlikely. But many have warned that a gentle, easy end to the current inflationary burst is not assured.

“It is way too soon to say it’s a pipe dream; it’s been a crazy year,” Jason Furman, an economist at Harvard University, said earlier this week of the possibility of a soft landing. “It feels, with every passing month, increasingly unlikely.”

Why the Fed is poised to raise interest rates.

The Fed increased the federal funds rate, a short-term borrowing cost for banks, in what officials have signaled is the first of a steady series of moves. Fed policy changes trickle out through other types of interest rates — on mortgages, car loans and credit cards. Some of the interest rates that consumers pay to borrow money have already moved higher in anticipation of the Fed’s coming adjustments.

Policymakers projected that six more similarly sized rate increases would happen this year.

That’s because inflation is hot.

The policy changes come at a challenging moment for central bankers: They are in charge of maintaining price stability, and inflation is running at the fastest pace in four decades. While officials expect price gains to moderate this year, how quickly and how much that will happen are uncertain, especially as war in Ukraine pushes up fuel costs and fresh virus restrictions in China threaten to perpetuate supply chain disruptions.

The Fed is also in charge of fostering maximum employment, but with hiring rapid and more open jobs than there are available workers, that goal appears to have been achieved, at least for now.

Higher rates are likely to slow strong consumer demand.

The idea behind raising rates is simple: Higher borrowing costs can slow down inflation by tempering demand. When it costs more to borrow, fewer people can afford houses and cars, and fewer businesses can afford to expand or buy new machinery. Spending pulls back (something we’re already beginning to see). With less activity happening, companies need fewer workers. Less demand for labor makes for slower wage growth, which cools demand further. Higher rates effectively pour cold water on the economy.

Fed changes could also hurt stock and other asset prices.

The effects of higher rates might be visible in markets. Higher interest rates tend to eventually lower stock prices — in part because it costs businesses more to operate when money is expensive to borrow, and in part because Fed rate increases have a track record of touching off recessions, which are terrible for stocks. Pricier borrowing costs also tend to weigh on the value of other assets, like houses, as would-be buyers shy away from the market.

The Fed is also preparing to shrink its balance sheet of bond holdings, and many economists expect Fed officials to release a plan to do so as soon as May. That could push up longer-term rates and will probably further pull down stock, bond and house prices.

The goal here is a soft landing.

You might wonder why the Fed would want to slow down the economy and hurt the stock market. The central bank wants a strong economy, but sustainability is the name of the game: A little pain today could mean less pain tomorrow.

The Fed is trying to get inflation down to a level where price increases do not influence people’s spending choices or daily lives. Officials hope that if they can slow the economy enough to reduce inflation, without damaging it so much that it tips into a recession, they can set the stage for a long and steady expansion.

“I think it’s more likely than not that we can achieve what we call a soft landing,” Mr. Powell said during recent testimony before lawmakers.

The Fed has let the economy down easy before: In the early 1990s it raised rates without sending unemployment higher, and it appeared to be in the process of achieving a soft landing before the pandemic struck, having raised rates between 2015 and 2018.

But economists have warned that it could be a tough act to pull off this time around.

“I wouldn’t rule it out,” Donald Kohn, a former Fed vice chair, said of a soft landing. But he said a clampdown on demand that pushed unemployment higher was also possible.

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What the Fed’s rate hike means for you.

The Fed says supply chain disruptions could prolong rapid inflation.

Fed officials still expect inflation to begin to slow this year, but they now believe that deceleration may take more time than they initially anticipated.

In a note to clients on Monday, economists at Goldman Sachs said the war could slow the world economy and push inflation up half a percentage point globally, with particularly dire consequences for Europe.

They added that shortages of parts and metals like aluminum, copper and palladium from Russia and Ukraine could hit automakers and other manufacturers, while disruptions to shipping could damp exports, including those of grains, in Europe, Africa and the Middle East.

Like many forecasters, the Fed has long expected Americans to reduce their spending on goods and shift more of their budgets back to services like movies, restaurants and travel as the pandemic subsides. That would give factories, ocean liners, ports and warehouses a chance to catch up. Two years into the pandemic, however, demand for imported goods has remained strong.

Mr. Powell said Wednesday that if the Fed had known that supply chain blockages would collide with strong demand, it would have been appropriate, in hindsight, to raise rates earlier. “But again, we don’t have that luxury,” he said.

The Fed’s actions won’t address supply chain bottlenecks directly, and many of the factors now driving inflation up are no longer tied directly or exclusively to supply chains. But as the central bank makes borrowing more expensive, demand for new cars and houses is likely to ease, alleviating some of the pressure on supply chains.

“Basically, across the economy, we’d like to slow demand so that it’s better aligned with supply; give supply, at the same time, time to recover; and get into a better alignment of supply and demand. And that, over time, should bring inflation down,” Mr. Powell said.

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Rate increases will cool inflation but could bring political costs for Democrats.

Jerome H. Powell, the Fed chair, said at a news conference on Wednesday that “the probability of a recession within the next year is not particularly elevated.”

But analysts said that achieving what is known as a soft landing will be hard, if not impossible.

“The bottom line here is that the Fed is well behind the curve in terms of battling inflation, and it is going to be difficult to walk a line between taming inflation and at the same time not dumping the economy into a recession,” Joshua Shapiro, the chief U.S. economist at the forecasting company Maria Fiorini Ramirez, wrote in a note to clients.

The Fed’s inflation-fighting mode also adds to an uphill battle by Mr. Biden and Democrats to pass another trillion-dollar spending package aimed at addressing climate change and advancing social policies. Republicans have warned it might exacerbate inflation and a key Democrat, Senator Joe Manchin III of West Virginia, has echoed those concerns.

“By raising interest rates, the Federal Reserve has begun the process of unwinding their pandemic-era stimulus measures in an effort to tame inflation,” said Greg McBride, the chief financial analyst at Bankrate. “Consumers can expect higher borrowing costs to be just another form of inflation, with rates for credit cards and home equity lines of credit notching higher in the next month or so.”

Republicans, who have generally backed Mr. Biden’s actions to support Ukraine and impose sanctions on Russia, have been working to prevent the White House from deflecting blame for inflation.

“As inflation continues to surge, the Biden White House has attempted to gaslight Americans into believing Biden’s inflation is ‘Putin’s price hike,’” the Republican National Committee said this week.

Some business groups said on Wednesday that the Biden administration’s policies had forced the Fed’s hand.

“While increased borrowing costs will hurt small businesses and economic growth, reckless spending by the Biden administration and congressional Democrats has left the Fed with no other choice,” said Alfredo Ortiz, chief executive of the right-leaning Job Creators Network. “Given how hot inflation is running, the Fed’s action today may be too little too late for many small businesses that have already been crushed by rising prices.”

Stocks rally after the Fed’s rate increase, for a second day of big gains.

“When the equity market started to listen to Chairman Powell, they were swayed a bit by his comments that, although there’s skepticism, the economy and the labor market are strong enough to withstand interest rates going into a restrictive level,” said Kathy Bostjancic, chief U.S. financial economist at Oxford Economics.

The Fed’s plan to raise rates this year comes with inflation at the highest level in 40 years. The Consumer Price Index rose 7.9 percent through February, with higher prices for gas, food and rent contributing to the increase.

Higher rates can hinder the stock market’s performance because they make owning bonds more attractive and make borrowing more expensive for consumers and companies. But the Fed’s decision to try to control the runaway price gains is also a welcome step to many on Wall Street who are worried about the economic damage inflation can cause as it erodes consumer sentiment and spending.

“High inflation takes a toll on everyone, but really, especially, on people who use most of their income to buy essentials like food, housing and transportation,” Mr. Powell said.

One measure of sentiment released this month — the University of Michigan’s Index of Consumer Sentiment — showed that consumers were pessimistic about the rest of the year because of inflation and the potential impact of the conflict in Ukraine. The Commerce Department also reported on Tuesday a slowdown in spending growth in February, with retail sales up 0.3 percent from the previous month after gain of 4.9 percent in January.

“It looks like we’re going to have a rate hike in every meeting moving forward because the Fed is worried about pricing pressures,” said Edward Moya, a senior market analyst at Oanda, a foreign currency exchange and brokerage firm.

Lenders stand to gain higher profits as interest rates on loans increase, and shares of big banks were higher on Wednesday. JPMorgan Chase rose 4.5 percent, while Citigroup and Bank of America climbed more than 3 percent. Wells Fargo also rose sharply.

In Europe, stock indexes rose, with the Stoxx Europe 600 up 3.1 percent. The gains came as peace talks between Ukraine and Russia continued for a third straight day, and Russian officials said the negotiations showed “progress on a number of positions.”

Energy markets were volatile on Wednesday, after fears over a slowdown in demand in China had triggered a drop in oil prices on Tuesday. Brent crude, the international standard, fell about 2 percent to about $98 a barrel.

Travel and leisure stocks continued to hold their footing on Wednesday, and were among the best performers in the S&P 500. Wynn Resorts gained 8.1 percent, while United Airlines rose 7.7 percent.

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The U.S. joins global peers in a battle against inflation.

In the eurozone, where inflation is at 5.8 percent, the European Central Bank has moved one step closer to increasing its interest rates for the first time in a decade. Last week, it proposed an end date for its bond-buying program, a precursor to higher interest rates, which are currently negative. Purchases will stop in the third quarter if the inflation outlook doesn’t weaken.

But the war in Ukraine, which has exacerbated rising energy and food prices, has clouded the outlook. German business leaders are increasingly fearful of a recession. While inflation is expected to stay elevated for longer, the European Central Bank has cut its expectations for economic growth.

“The risks to the economic outlook have increased substantially,” Christine Lagarde, the president of the bank, said last week.

Jerome Powell took questions from reporters.