Fed To Hike Rates In 2023 But Dots Won’t Show It, Economists Say
A strong recovery from the Covid-19 recession is likely to prompt Federal Reserve Chair Jerome Powell and his colleagues to lift interest rates in 2023, but that isn’t going to show up in their forecasts this week, a survey showed. Fed To Hike Rates In 2023 But Dots Won’t Show It, Economists Say
Economists surveyed by Bloomberg News see two quarter-point hikes in 2023. But they also expect the U.S. central bank’s own forecast, released at the same time as its policy statement at 2 p.m. in Washington on Wednesday, will show the median Fed official projecting rates staying on hold near zero throughout that year.
Such a result would match the Fed’s December projections, even though U.S. lawmakers have backed almost $3 trillion in fiscal stimulus since then, including $1.9 trillion that President Joe Biden signed into law on Thursday, which — together with accelerating vaccinations — is boosting the economic outlook.
“The Fed is now probing the unknown as a powerful trio of massive fiscal stimulus, monetary support and pent-up demand impact an economy released by the widespread dissemination of vaccines,” economist Lynn Reaser of Point Loma Nazarene University said in a survey response.
The Federal Open Market Committee is almost certain to keep rates near zero and pledge to continue its asset purchases at the current $120 billion monthly pace at its second meeting of the year.
Powell has repeatedly stressed that the U.S. labor market remains far from the Fed’s goal of full employment, making it too soon to discuss winding down Fed support as the world marks the one-year anniversary of the pandemic.
Even so, three-quarters of the economists forecast the central bank will have to raise rates by the end of 2023, where the median respondent has estimated about 50 basis points of tightening. By contrast, the median in Bloomberg’s December survey had no change in rates until 2024 or later.
What Bloomberg’s Economists Say…
“While the economic projections will change, we do not expect rate expectations to move much at all. In fact, while a few dots may drift higher on the dot plot, we expect the center of the Committee to hold the line in terms of not acknowledging any change in the exit timeline.”
— Carl Riccadonna, economist
The committee, making its first quarterly economic forecasts of the year, will raise its estimates of 2021 growth and edge up the inflation call, while not bringing forward a winding down of asset purchases or interest-rate hikes, in the view of the 41 economists, who were surveyed March 5-10.
The Fed’s closely watched forecasts are likely to show gross domestic product increasing 5.8% in 2021, the survey found, up from 4.2% in the Fed’s December projections. Inflation is seen slightly higher than three months ago, with the unemployment rate falling to 5.0% at year’s end, the same as in the December projections.
The FOMC is likely to continue to forecast near-zero rates through 2023, though it’s a close call, with a third of economists surveyed looking for a median Fed projection of higher rates by then.
In December, one official penciled in a quarter-point increase during 2022, with five seeing hikes in 2023.
“Having a forecast of rising rates seems very unlikely when we are just beginning to discuss how much inflation will move up, for how long, how much the unemployment rate will drop,” said Nathaniel Karp, BBVA chief U.S. economist. “The Fed has to see it, feel it, not just dream about it.”
A sharp rise in U.S. Treasury yields in the past month as economic-growth forecasts picked up has caught the eye of the central bank. Powell and others have attributed the increases to improving prospects and said they don’t appear to be troubling.
The FOMC is unlikely to highlight the risk of tightening financial conditions in its statement or strengthen its forward guidance on interest rates or bond buying, the survey found.
The committee has pledged to continue the current pace of asset purchases until there’s “substantial further progress” on employment and its 2% inflation goal.
“The FOMC will remain in wait-and-see mode for the time being, with no major change in the statement, rate-hike timing, or inflation projections expected at this meeting,” said Scott Anderson, Bank of the West chief economist, in a survey response.
When To Taper
Powell has said the economy isn’t close to achieving the necessary progress to trigger a shift in bond buying and that he will signal any tapering well in advance. That isn’t seen happening until 2022 in the view of a narrow majority of economists.
Most of the surveyed economists also don’t expect any near-term change, such as a shift to buying long-term Treasuries. Even less likely would be altering the mix of Treasury and mortgage-backed securities, or placing a numerical target on Treasury yields, known as yield-curve control, they said.
Powell’s current term as chair is scheduled to end next February. His highly accommodative policies could win him a second stint, according to the economists. About three-quarters expect him to continue in the job, which is about the same finding in the prior survey.
The central bank has occasionally made a technical change to its interest rate on excess reserves, which would not affect monetary policy. Most economists are not looking for a change in March, however.
The Fed Should Get Out Of The Mortgage Market
Even central bankers are starting to wonder why they’re adding $40 billion of housing debt every month.
If the Federal Reserve is truly as outcome-based as it claims to be under its new policy framework, it should start winding down its purchases of mortgage-backed securities. The fact that it’s not even thinking about doing so is revealing about just how hesitant it is to make even the slightest tweaks to monetary policy at this point in the economic recovery.
Lost in the shuffle last week amid all the Fedspeak about inflation and Friday’s shocking jobs report were comments from Boston Fed President Eric Rosengren. “My own personal view is that the mortgage market probably doesn’t need as much support now.
And in fact, one of my financial stability concerns would be if the housing market gets too overheated,” he said. “I do think that as we think about tapering one of the things that we are going to have to think about is at what speed we taper the Treasuries versus the mortgage-backed securities.”
While Rosengren also added to the central bank consensus that it remains premature to focus on tapering, a view only reinforced by the U.S. labor market adding surprisingly few workers last month, he raises an interesting question:
Why exactly is the Fed still increasing its holdings of mortgage-backed securities by $40 billion a month when Chair Jerome Powell himself has said that “the housing sector has more than fully recovered from the downturn” and that the rapid price appreciation means “it just is going to be that much harder for people to get that first house.” Couldn’t the Fed be using its bond-buying bazooka more effectively?
It certainly seems that way, especially when gauging sentiment within the agency mortgage-bond market itself. “Outside of the central bank today, there was little impetus to buy,” my Bloomberg News colleague Christopher Maloney noted. Banks “mostly joined other investors on the sidelines, waiting for wider spreads.”
The option-adjusted spread on the Bloomberg Barclays U.S. MBS index fell to just 0.07% at the end of April, the narrowest since 2010. It’s no secret why: The Fed has gobbled up almost $2 trillion of MBS since March 2020, which is more than its total aggregate purchases in any of its previous quantitative easing episodes.
As I mentioned on Twitter during Powell’s press conference in April, the Fed doesn’t have a satisfactory answer for why it’s throwing billions of dollars at mortgage bonds at this point.
His answer boiled down to three things: First, that the MBS market was in chaos during the onset of the pandemic; second, that it bought them after the 2008 financial crisis so it should do so again; and third, MBS purchases are now inextricably linked to tapering in general, so it’s stuck buying them until it reaches the nebulous “substantial further progress” mark. Here’s Powell’s quote in full, which doesn’t even fully capture his struggle to answer:
“Yeah. I mean, we started buying MBS because the mortgage-backed security market was really experiencing severe dysfunction, and we’ve sort of articulated, you know, what our exit path is from that.
It’s not meant to provide direct assistance to the housing market. That was never the intent. It was really just to keep that as, it’s a very close relation to the Treasury market, and a very important market on its own.
And so, that’s why we bought as we did during the global financial crisis. We bought MBS, too. Again, not intention to send help to the housing market, which was really not a problem this time at all. So, and, you know, it’s a situation where we will taper asset purchases when the time comes to do that, and those purchases will come to zero over time. And that time is not yet.”
This is the point where it’s important to differentiate between what the Fed should do and what the Fed will do. Every indication is that the central bank won’t touch its MBS buying until it starts a complete tapering, at which point investors like Bob Michele, global head of fixed-income at JPMorgan Asset Management, see the Fed cutting its purchases of U.S. Treasuries by $10 billion a month and MBS by $5 billion.
If that starts in January 2022 as Michele suggests, that means the Fed will still have its hands in the mortgage market more than a year from now. That will probably happen, even though it feels unnecessary.
What should the Fed do? Easy: It could simply put its $120 billion of monthly bond buying to better use by shifting from MBS to long-term Treasuries until it reaches “substantial further progress.” This is effectively what Bank of America Corp. strategists argued for almost two months ago in what they dubbed “Operation Switch.” They said “the MBS market is showing increasing signs the Fed may be too large,” citing “a growing list of market dysfunction.”
They urged policy makers to consider that “a ‘switch’ is not a ‘taper,’ rather it shows the Fed willing to address market dysfunction and establishes a longer runway to its end goals.” Another option, which Rosengren seemed to allude to, would be communicating that when it tapers, it will aggressively wind down the MBS side first.
Of course, the Fed hardly pretends to be so nimble. “Quantitative easing is an inexact science, and what we’re doing right now is supporting certainly the housing market, supporting financial markets generally, keeping the yield curve lower, keeping the 10-year down,” Minneapolis Fed President Neel Kashkari said Friday on Bloomberg TV. “Could somebody argue instead of being 120, is should be 110? Sure, we can have that debate. But it’s an inexact science.”
As long as U.S. housing prices increase year-over-year by more than 10%, as they have for each of the past three months, Fed officials should continue to face questions about the central bank’s presence in the mortgage market. After all, no one is asking for them to do this. Would-be MBS buyers are sitting out, waiting for spreads to widen, suggesting the MBS market would function just fine without central-bank meddling.
Look no further than corporate bonds, where investors are all too eager to buy debt from companies with deeply speculative-grade ratings, for proof that there’s no shortage of demand for debt with a bit of extra yield. That includes appetite from banks that are flush with extra reserves specifically because of the Fed’s balance-sheet expansion.
In the end, the Fed seems content to be like the unwanted guest at a house party who just won’t leave. No one is going to kick the central bankers out, but it might be nice if they gave some indication that they’re exiting soon.
Don’t Fear The Taper: Fed To Dominate Treasury Market For Years
Treasury investors fretting about when the Federal Reserve will scale back its bond purchases may be missing the bigger picture: Its more than $5 trillion stockpile will make it a major force for years to come.
The prospect of a pullback in buying edged a little nearer Wednesday when minutes of the Federal Open Market Committee’s April meeting showed that a number of officials were willing to discuss it if the economy keeps improving. Yields rose on the news.
But bond bulls say the Fed’s virtually inextricable presence in the world’s largest bond market means it will provide crucial support long after any price blips come and go when it brings the buying spree to a close.
The central bank’s Treasury holdings have doubled since March 2020, accounting for nearly one-quarter of the total outstanding, a bigger share than it held even after the 2008 credit crisis.
It’s a result of aggressive moves to keep the market functioning and hold down rates on everything from mortgages and car loans to corporate and municipal bonds.
“The Fed will have a big hand in fixed-income markets for as far as the eye can see,” said Matt Nest, portfolio manager and global head of active fixed income for State Street Global Advisors.
The stake is so large that even once the Fed’s purchases wind down, it is expected to keep its holdings steady by buying new Treasuries whenever old ones mature, reducing the amount that would need to be sold to the public. That’s given some investors confidence that rates won’t rise too quickly — or by too much — even as yields head back toward the approximately 14-month high hit in March amid fears the economy is at risk of overheating.
“The Fed is definitely not going anywhere anytime soon with regard to the Treasury market,” said Mike Pugliese, an economist at Wells Fargo Securities, which predicts the Fed will begin tapering its purchases in January 2022 and end them around November.
But he expects the central bank to keep its stake steady through the next four years. “The Fed is going to comfortably hold between 20% to 25% of the Treasury market, remaining the largest holder of Treasuries, until about 2025,” he said.
That backdrop, combined with the prospect the government’s debt managers will cut note and bond auctions later this year as the economy rebounds, is helping to keep yields low despite the sharp pickup in growth and rising consumer prices. The Treasury’s net private borrowing of notes and bonds will fall next year to $1.99 trillion, from $2.75 trillion this year, according to JPMorgan Chase & Co.
The central bank’s holdings of Treasuries have been growing by $80 billion a month, and it’s also adding $40 billion in mortgage debt to its balance sheet. That’s left it on course to buy a total of $960 billion of Treasury notes and bonds in the secondary market this year after snapping up $2.18 trillion last year. Strategists at JPMorgan predict the Fed will buy $390 billion more in 2022 before wrapping up its purchases.
The minutes of the FOMC meeting reported that “a number of participants suggested that if the economy continued to make rapid progress toward the Committee’s goals, it might be appropriate at some point in upcoming meetings to begin discussing a plan for adjusting the pace of asset purchases.”
The prospect of a such a slowdown has sown some consternation. The 10-year Treasury yield rose to the day’s high after the minutes, reaching 1.69% as traders boosted bets on the outlook for Fed rate hikes. Those gains weren’t sustained and the yield has fallen about 2 basis points to 1.65% Thursday.
The benchmark yield is just a little more than half the average of the past two decades, and some analysts are confident that Fed Chair Jerome Powell and his colleagues will take a cautious approach to winding down quantitative easing.
“The Powell Fed is skittish about touching any aspect of its balance sheet, which is why it’ll be slow to slow asset purchases and will never sell securities outright on the back end of QE,” said former Fed official and Mellon chief economist Vincent Reinhart.
Traders Ramp Up Bets On A Hawkish Fed Surprise At Jackson Hole
Peter Yi, head of taxable credit research at Northern Trust Asset Management, thinks there’s limited upside to long-term Treasury yields. He expects the 10-year yield to swing between 1.25% and 1.75% through the rest of 2021 and has been buying when yields back up. Percolating inflation, with U.S. consumer prices climbing in April by the most since 2009, will prove temporary, he added.
“The Fed has tools in their toolkit that they are going to use if they absolutely need to do it to prevent 10-year yields from jumping dramatically and in a disorderly way,” Yi said.
The last time the Fed began to pull back from asset purchases was from January through October 2014, when it unwound the quantitative easing measures ushered in after the 2008 credit crisis.
While Treasury yields rose in 2013 in anticipation of that, the effects were muted, with yields falling in 2014.
The Fed was in no rush to unload its bond holdings, however, and kept rolling them into new securities when they matured. In October 2017, the bank began to whittle down its portfolio, only to stop abruptly in September 2019 when it caused mayhem in the overnight lending market.
Unhinged Money Markets Trigger Fed Action to Alleviate Stress
Dan Krieter, a strategist in BMO Capital Markets’ fixed-income strategy group, doesn’t see the Fed shrinking its balance sheet for years.
“It’s becoming harder and harder for the Fed to ever extricate itself from the financial system,” Krieter said. “At least for the next five or so years, the Fed isn’t even going to hint at the idea of reducing its balance sheet.”
Fed Officials Could Pencil In Earlier Rate Increase At Meeting
Quarterly economic forecasts are likely to project significantly higher inflation and growth than Fed officials expected in March.
Federal Reserve officials could signal this week that they anticipate raising interest rates sooner than previously expected following a spate of high inflation readings.
In March, the last time they released quarterly economic forecasts, most officials expected to keep the Fed’s benchmark interest rate near zero through 2023 to encourage the economy’s recovery from the pandemic. Officials are set to release updated projections Wednesday after a two-day policy meeting.
Fed officials in March saw consumer prices rising 2.4% in the fourth quarter of 2021 from a year earlier. That pace, they said, would be consistent with their goal of 2% average annual inflation over the long run.
Inflation has soared since then, as the economy has rebounded much faster than expected, businesses have struggled to hire workers, and shortages of key materials have wreaked havoc on supply chains.
The Labor Department’s consumer-price index jumped 5% in May from a year earlier, following a 4.2% increase in the 12 months through April.
For inflation to meet officials’ March forecasts, prices would have to not only stop rising but fall over the rest of the year. Barclays Bank PLC now expects annual inflation, measured by the Fed’s preferred gauge, to hit 3.6% in the fourth quarter—nearly double the central bank’s target.
Fed officials’ individual March projections, charted in their so-called dot-plot, showed all 18 policy makers expected to leave interest rates unchanged through this year. Four expected to start lifting rates next year, and seven projected that rates would be higher by the end of 2023.
The new dot-plot coming Wednesday could show more individuals expect to raise rates in 2022 or 2023, analysts say. A June survey of 127 market participants by MacroPolicy Perspectives LLC showed 68% of respondents expecting at least one rate increase in 2023.
JPMorgan Chase chief U.S. economist Michael Feroli said he now expects the dot-plot to show a median expectation of a rate increase in 2023.
“We are also bringing forward our expectations for liftoff to late 2023,” he said in a note Friday.
Signs of surging inflation have emerged faster than the Fed anticipated as recently as its April policy meeting. Fed officials haven’t publicly commented on the May inflation report because it was released Thursday during their self-imposed blackout period, when they refrain from speaking publicly on monetary policy ahead of their meeting.
Before the blackout period began on June 5, officials repeatedly said they expected this year’s inflation surge to prove transitory, but they also cautioned that they will raise rates if needed to keep inflation under control.
“Should inflation move materially and persistently above 2 percent, we have the tools and experience to gently guide inflation back down to target. And no one should doubt our commitment to do so,” Fed governor Lael Brainard said in a speech June 1.
The Fed in August adopted a new approach to setting interest rates by dropping its longstanding practice of raising them pre-emptively to prevent inflation from exceeding its 2% target. Instead, it wants inflation to average 2% over time, a more flexible objective. Since August, the Fed has said it would aim for inflation to run moderately above that level for a while to make up for many years of shortfalls.
Policy makers have said since December that they wouldn’t raise rates until inflation hit 2% and is forecast to exceed that level for some time and the economy has achieved maximum employment.
The labor market’s progress this year has been slower than officials had hoped. In recent weeks, some Fed officials have indicated they may lower the number of job gains required to reach maximum employment, because of the wave of retirements since the pandemic began.
Fed officials at their meeting this week are also likely to begin discussing when and how to start reducing the central bank’s monthly purchases of Treasury and mortgage bonds. When they have wound down previous bond-purchase programs, they let the so-called tapering process run its course before raising interest rates. Many economists expect tapering to begin around the end of this year or in early 2022.
In a statement after their April policy meeting, Fed officials said the economy needed to make “substantial further progress” toward maximum employment and sustained 2% inflation before they would begin reducing bond purchases.
Fed officials’ updated forecasts are also likely to show they expect the economy to grow faster this year than the 6.5% they projected in March. Goldman Sachs & Co. LLC economists estimate growth of 7.7% this year, helping to push inflation to 3.5% in the fourth quarter from a year earlier.
Fed’s Bullard Pencils In Rate Increase In 2022
St. Louis Fed President questions continued mortgage-bond purchases amid robust housing market.
Federal Reserve Bank of St. Louis President James Bullard said the economy is seeing more inflation than he and his Federal Reserve colleagues anticipated only a few months ago, and that he now expects to see a central bank rate increase next year.
Speaking Friday on CNBC, Mr. Bullard said that when he submitted forecasts at this week’s Federal Open Market Committee meeting, “I put us starting in late 2022” with the first move up from near-zero short-term interest rates currently. Ahead of the FOMC meeting, Mr. Bullard had said he wasn’t ready to call for a shift in monetary policy while the coronavirus pandemic was still a major force for the economy.
At the meeting, Fed officials opened the door to the option of paring some of the massive stimulus they have been providing the economy during the pandemic.
Officials projected a stronger economic outlook with notably more inflation this year. And while they still all agree no rate increase will happen this year, they moved to pencil in increases through 2023, compared with no projected increases in the March forecasts. Officials now believe the Fed will have lifted rates twice by 2023.
Mr. Bullard doesn’t currently have a vote on the FOMC, and he was the first official to weigh in after this week’s meeting. Seven of 18 Fed officials expect one or more increases next year.
Despite that shift, Fed Chairman Jerome Powell at his press conference after the FOMC meeting cautioned that “rate increases are really not at all the focus of the committee” right now. “The real near-term discussion that we’ll begin is really about the path of asset purchases” and when the central bank will be able to pull back on that, he added.
When it comes to boosting rates, “we did not actually have a discussion of whether liftoff is appropriate at any particular year because discussing liftoff now would be—would be highly premature,” Mr. Powell said. He also cautioned against reading too much into the so-called dot plot that maps the individual expectations of Fed officials of the level of interest rates, which he again noted wasn’t an official forecast of the central bank.
As part of his argument for a rate increase next year, Mr. Bullard noted in his television interview that “the inflationary impulse, I think, is more intense than we were expecting.” He added that, “you could see even some upside risks to the inflation forecast, but that’s OK” given that the Fed had hoped to get inflation back up over 2% for a time to make up for extended periods of falling short of that goal.
At the FOMC meeting, officials projected 3.4% inflation this year, compared with 2.4% forecast in March.
Most Fed officials believe inflation will jump this year as the economy reopens and subside next year as supply bottlenecks and other disruptions are sorted out.
Mr. Bullard also noted Mr. Powell opened the door Wednesday to a debate at the Fed on reducing its bond-buying stimulus. The Fed is currently buying $80 billion a month in Treasury bonds and $40 billion a month in mortgage bonds to help smooth markets and provide stimulus beyond its near-zero short-term rate target.
“The taper discussion is open and the chair made that very clear. But it’s going to take several meetings to get organized on all these different points,” Mr. Bullard said, suggesting a pull back in the buying isn’t imminent.
Mr. Bullard also said the U.S. economy “is in an environment where we’ve got a lot of volatility, so it’s not at all clear that any of this will pan out the way anybody’s talking about.”
He added that monetary policy makers will need to be “nimble” given the uncertain path of the recovery.
The policy maker, who became leader of the St. Louis Fed in 2008, questioned whether the Fed should still be buying mortgage-bond securities given the strength of home sales.
“I’m leaning a little bit toward the idea that maybe we don’t need to be in mortgage-backed securities with a booming housing market and even a threatening housing bubble here, according to some people,” Mr. Bullard said. “We don’t want to get back in the housing bubble game that cost us a lot of distress in the 2000s.”
While some Fed officials are also interested in paring mortgage bonds, others believe the central bank’s purchases of the securities are a broad benefit to financial conditions.
Fed Likely Needs To Raise Rates As Soon As Late 2022, IMF Says
The Federal Reserve probably will need to begin raising interest rates in late 2022 or early 2023 as increased government spending keeps inflation above its long-run average target, according to the International Monetary Fund.
The U.S. central bank likely will begin to scale back asset purchases in the first half of 2022, staff from the Washington-based fund said in a statement Thursday following the conclusion of so-called article IV consultations, the IMF’s assessment of countries’ economic and financial developments following meetings with lawmakers and public officials.
“Managing this transition — from providing reassurance that monetary policy will continue to deliver powerful support to the economy to preparing for an eventual scaling back of asset purchases and a withdrawal of monetary accommodation — will require deft communications under a potentially tight timeline,” IMF staff said in the concluding statement.
The Fed held interest rates near zero at its June 15-16 meeting and signaled it would probably keep them there through next year to help the U.S. economy recover from Covid-19. Officials penciled in two rate hikes for 2023 and seven of the 18 policy makers want to raise rates in 2022, up from four in March.
Fed Chair Jerome Powell has said that recent steep increases in inflation will prove to be largely transitory due to bottlenecks and that expectations on the whole are where the Fed wants them.
The personal consumption expenditures price gauge that the Fed uses for its inflation target rose 3.9% in May from a year earlier, the most since 2008. The IMF forecasts the increase to be transitory, with the index peaking at 4.3% and dropping to around 2.5% by the end of 2022. That’s still above the Fed’s long-run average target of 2%.
At its June meeting, the Federal Open Market Committee marked up all its inflation forecasts through the end of 2023, with officials seeing personal consumption expenditures — their preferred measure of price pressures — rising 3.4% in 2021 compared with a March projection of 2.4%. They increased the 2022 forecast to 2.1%, and 2.2% for the following year.
Fund staff estimates that the higher U.S. spending proposed by President Joe Biden in the infrastructure-focused American Jobs Plan and the social-spending-based American Families Plan — which have yet to pass — would increase growth in gross domestic product by a cumulative value of about 5.25% from 2022 to 2024.
The IMF raised its estimate for U.S. economic expansion this year to 7% — the fastest pace since 1984 — from a 6.4% forecast in April.
Lawmakers have release a wave of pandemic-relief funds over the past 15 months to buoy the economy with the $1.9 trillion American Rescue Plan passed in March, a $900 billion package approved in December and the $2 trillion Cares Act of March 2020.
“The unprecedented fiscal and monetary support, combined with the receding Covid-19 case numbers, should provide a substantial boost to activity in the coming months,” the IMF said. “Savings will be drawn down, demand will return for in-person services, and depleted inventories will be rebuilt.”