The U.S. economy grew 5.7% in 2021, the U.S. Bureau of Economic Analysis reported today, the fastest pace for a full year since 1984. It grew even faster in the final quarter of last year, at 6.9%, the bureau reported.
The rapid growth is surprising given the ongoing COVID-19 pandemic and has led many in Congress and the business community to call for the Federal Reserve to take action to tame rampant inflation.
Wednesday, following the conclusion of the Federal Open Market Committee’s (FOMC) two-day meeting, Chairman Jerome H. Powell indicated that a dramatic change in monetary policy is coming — more than likely in March.
Just prior to the start of Powell’s news conference, the Fed released a statement summing up its plans for the near term:
- The Fed will end its purchases of Treasury bonds and mortgage-backed securities in early March.
- It will, for now, hold the federal funds rate at 0 to 0.25%, and
- It will raise the target range for that rate “soon” — which most experienced Fed observers translate to mean it will occur during the FOMC’s next meeting, scheduled for March 15-16.
In its statement, the Fed said economic indicators continue to improve overall, but risks remain.
“The sectors most adversely affected by the pandemic have improved in recent months but are being affected by the recent sharp rise in COVID-19 cases,” the statement said. “Job gains have been solid in recent months, and the unemployment rate has declined substantially. Supply-and-demand imbalances related to the pandemic and the reopening of the economy have continued to contribute to elevated levels of inflation. Overall financial conditions remain accommodative, in part reflecting policy measures to support the economy and the flow of credit to U.S. households and businesses.”
The statement noted that the path of the economy “continues to depend on the course of the virus,” with increased vaccinations and “an easing of supply constraints expected to support continued gains in economic activity and employment, as well as a reduction in inflation.” It acknowledged that potential new variants of the virus could pose risks to the economic outlook.
The FOMC continues to work towrrd its goals of achieving maximum employment and a 2% inflation rate long-term. “In support of these goals," the statement said, "the Committee decided to keep the target range for the federal funds rate at 0 to 0.25%. With inflation well above 2% and a strong labor market, the Committee expects it will soon be appropriate to raise the target range for the federal funds rate.”
In addition, the FOMC "decided to continue to reduce the monthly pace of its net asset purchases, bringing them to an end in early March.”
The statement said that, beginning in February, the FOMC will increase its holdings of Treasury securities by at least $20 billion per month, and of agency mortgage‑backed securities by at least $10 billion per month. Throughout the course of the pandemic, the Fed had built its balance sheet to $8.5 trillion by the end of 2021.
“The Federal Reserve's ongoing purchases and holdings of securities will continue to foster smooth market functioning and accommodative financial conditions, thereby supporting the flow of credit to households and businesses,” the statement said.
Still, the Fed said it is "prepared to adjust the stance of monetary policy as appropriate.”
To do that, it will monitor a wide range of data, including readings on public health, labor-market conditions, inflation pressures and expectations, and financial and international developments.
In addition to its statement on monetary policy, the Fed released a separate statement outlining the principles that will guide reducing its balance sheet. They include:
- The FOMC said it views changes in the target range for the federal funds rate "as its primary means of adjusting the stance of monetary policy." During his news conference, Powell stressed this point, stating that asset sales would occur “in the background.”
- The FOMC will determine the timing and pace of reducing the Fed’s balance sheet to promote its maximum employment and price-stability goals. The FOMC expects to begin reducing its balance sheet after the target range for the federal funds rate has increased.
- The FOMC intends to reduce the Fed's securities holdings over time in “a predictable manner primarily by adjusting the amounts reinvested of principal payments received from securities held in the System Open Market Account (SOMA).”
- It intends to maintain securities holdings in amounts needed “to implement monetary policy efficiently and effectively in its ample reserves regime.”
- In the longer run, it intends to hold primarily Treasury securities in the SOMA, “thereby minimizing the effect of Federal Reserve holdings on the allocation of credit across sectors of the economy.”
- Lastly, the FOMC is prepared “to adjust any of the details of its approach to reducing the size of the balance sheet in light of economic and financial developments.”
Both the monetary policy statement and the statement of balance sheet reduction principles were approved unanimously by the FOMC members present.
Mike Fratantoni, senior vice president and chief economist for the Mortgage Bankers Association (MBA), said the Fed’s statement on interest rates was expected.
“(The) clear signal from the Federal Reserve that they will hike rates in March was no surprise, given the strong job market and inflation well above the 2% target,” he said. “Similarly, the Fed’s move to quickly end any further growth to their balance sheet, thereby reducing accommodation at the longer end of the yield curve, also makes sense given the evolution of the economy.”
Fratantoni, however, said the news from the Fed on Thursday “was the release of principles regarding how the Fed will think about moving from their current almost $9 trillion balance sheet to a smaller portfolio over time. While the experience shrinking the balance sheet in the last cycle was instructive, we do expect that the Fed will move to begin allowing runoff more quickly this time and at a faster pace once it starts.”
He noted that “the principle that they would like to return to a balance sheet that is primarily Treasuries at some point hints at some additional pressure on MBS yields over the medium term.”
Based on the Fed’s statements, Fratantoni said the MBA “is holding on to our forecast that the combination of a stronger economy, persistent inflation, and the reduction of monetary policy accommodation will all push towards somewhat higher mortgage rates, with the 30-year fixed rate hitting 4% by the end of 2022.”
