Following this Wednesday’s meeting of the Federal Open Market Committee (FOMC), the Federal Reserve (FED) will raise interest rates -which remain at almost 0- by the end of 2023, earlier than they had reported at their last meeting in March.
According to projections, the FED will raise interest rates around 0.6% by the end of 2023. The announcement to raise interest rates earlier than expected indicates two things: that the FED expects unemployment to reach its natural rate (around 3%) by 2023, and that the inflation currently being experienced by the U.S. economy is transitory and is due to cyclical factors rather than to the current management of monetary policy in the United States.
According to the latest Bureau of Labor Statistics report, 12-month cumulative inflation in May exceeded 5%, however, this inflation may be due to cyclical factors such as semiconductor shortages, increased demand following the lifting of pandemic restrictions, and rising oil and gasoline prices, driven by the build-up of oil reserves by the Organization of the Petroleum Exporting Countries.
The path of the economy will depend significantly on the course of the virus. Progress on vaccinations will likely continue to reduce the effects of the public health crisis on the economy, but risks to the economic outlook remain.”The path of the economy will depend significantly on the course of the virus. Progress on vaccinations will likely continue to reduce the effects of the public health crisis on the economy, but risks to the economic outlook remain,” the Fed said in its statement explaining why it will continue with interest rates near zero.
Although many economists have said that the U.S. economy is overheating, for the FED this does not appear to be the case: “With inflation having run persistently below this longer-run goal, the Committee will aim to achieve inflation moderately above 2 per cent for some time […]”.
The Fed also acknowledges that economic activity has strengthened, along with employment growth. Unfortunately, this second indicator remains below its ideal target to ensure a solid recovery in unemployment.
Fed to raise interest rates in 2023 and reduce bond purchases
Fed Chairman Jerome Powell at a press conference stated that the FOMC is considering a gradual reduction of the massive debt bond purchases that the central bank has been implementing since the beginning of the pandemic, however the start of the change in this policy remains uncertain.
Since June 2020 the Fed has been buying the equivalent of almost $120 billion in Treasury bonds and mortgage securities to keep the nation’s long-term borrowing costs low. The central bank made it clear that it will continue bond purchases until there is “substantial progress further down the road.”
Fed officials plan to bring the economy to its goal of maximum employment with long-term inflation of 2%, a goal they believe they will be able to meet before they are forced to raise interest rates and reduce bond purchases.
Some investors expect the Fed to raise interest rates before 2023. However, even if inflation falls out of its optimal range, raising rates could be dangerous, since thanks to the high levels of both government and corporate debt, interest rates would skyrocket leaving the government and the corporate sector struggling to service the debt.