[Summary] US Fed Signals March Rate Hike... Powell Also Says "Plenty of Room to Raise"

[Image source=Reuters Yonhap News]

[Asia Economy New York=Special Correspondent Joselgina] "There is quite a bit of room to raise interest rates without threatening the labor market." (Jerome Powell, Fed Chair)

The U.S. central bank, the Federal Reserve (Fed), indicated a rate hike in March. Regarding the balance sheet reduction, it did not specify a concrete timeline but disclosed the principle of reducing it in a predictable manner.

On the 26th (local time), the Fed announced after the Federal Open Market Committee (FOMC) regular meeting that it would keep the benchmark interest rate unchanged at the current level (0.00~0.25%). The FOMC assessed the recent economic situation by stating, "Economic activity and employment indicators continue to be strong but are affected by COVID-19." It also said, "Inflation is expected to improve due to expanded vaccination and easing supply constraints," but noted that "risks remain in the economic outlook due to variant viruses."

The signal to raise rates soon was also made clear. The FOMC mentioned, "Inflation is well above the (target) 2%, and the labor market is strong, so it is appropriate to raise the target range for the federal funds rate 'soon'." Although no specific date was mentioned, a hike is likely at the March FOMC meeting when tapering ends. This would be the first increase since December 2018.

Chairman Powell also confirmed his stance on sufficient room for rate hikes during the press conference following the regular meeting. Powell’s statement, "There is quite a bit of room to raise rates without threatening the labor market," is interpreted as a strong hawkish signal.

In particular, he reiterated concerns about inflation, which is at its highest level in 40 years. He emphasized, "We are committed to the goal of price stability" and "We will use all available tools to prevent inflation from becoming entrenched." Price stability, along with employment, is a key objective of the Fed’s monetary policy.

Powell did not definitively state whether rates would be raised in March but said, "If conditions permit, we could raise rates in March." This indicates that if inflation worsens, the Fed will use rate hikes as a primary policy tool. He also added, "The economy no longer needs strong monetary policy support." Regarding the specific schedule for balance sheet reduction, he said it could proceed after the rate hike tool is used.

The statement did not include hints about the size of the rate hike. Currently, the market is considering the possibility that the Fed, struggling with inflation, might surprise with a 0.5 percentage point increase at once. Powell did not give a precise answer when asked if they would raise rates by 0.5 percentage points at once.

Meanwhile, regarding the much-watched balance sheet reduction, the Fed also disclosed a separate stance to reduce it "in a predictable manner." However, it did not specify when or by how much the nearly $9 trillion expanded balance sheet would be reduced. The FOMC stated, "Balance sheet reduction is expected to begin after the process of raising the federal funds rate target range starts."

Even after the FOMC statement was released, the New York stock market, which had been strong, turned to a broad decline during Powell’s press conference. As of 3:36 p.m. Eastern Time, the Dow Jones Industrial Average was trading down 0.69% at 34,059.52 compared to the previous close. The S&P 500 index was down 0.46% at 4,336.63, and the Nasdaq index was down 0.22% at 13,509.77.

The benchmark U.S. 10-year Treasury yield rose to 1.848%. The Chicago Board Options Exchange (CBOE) Volatility Index (VIX), known as Wall Street’s ‘fear gauge,’ was up 1.67% at 31.68 compared to the previous close.