Fed Sees Two Rate Hikes by End of 2023, Inches Towards Taper

The Marriner S. Eccles Federal Reserve building stands in Washington, D.C., U.S. (Photographer: Erin Scott/Bloomberg)

Fed Sees Two Rate Hikes by End of 2023, Inches Towards Taper

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Federal Reserve officials sped up their expected pace of policy tightening amid optimism about the labor market and heightened concerns for inflation.

Fed Chair Jerome Powell told a press conference Wednesday that officials would begin a discussion about scaling back bond purchases used to support financial markets and the economy during the pandemic.

They also released forecasts that show they anticipate two interest-rate increases by the end of 2023 -- sooner than many thought -- and they upgraded estimates for inflation for the next three years.

“The economy has clearly made progress,” Powell said after a two-day gathering of the Federal Open Market Committee. “You can think of this meeting as the talking-about-talking-about meeting, if you like,” he added, referring to the discussion about tapering purchases.

Fed Sees Two Rate Hikes by End of 2023, Inches Towards Taper

The central bank held the target range for its benchmark policy rate unchanged at zero to 0.25%, where it’s been since March 2020, and maintained the $120 billion pace of its monthly bond purchases. The Federal Open Market Committee vote was unanimous.

The more aggressive signal from the Fed’s forecasts saw the dollar rise, stocks decline and yields on 10-year Treasuries jump.

Fed Sees Two Rate Hikes by End of 2023, Inches Towards Taper

“It’s a hawkish surprise,” said Thomas Costerg, senior U.S. economist at Pictet Wealth Management, referring to the rate projections. “We are looking at a Fed that seems positively surprised by the speed of vaccinations and the ongoing withdrawal of social-distancing measures.”

The quarterly projections showed 13 of 18 officials favored at least one rate increase by the end of 2023, versus seven in March. Eleven officials saw at least two hikes by the end of that year. In addition, seven of them saw a move as early as 2022, up from four.

“The dots should be taken with a big grain of salt,” Powell said, referring to the interest-rate forecasts. He cautioned that discussions about raising rates would be “highly premature.”

The Fed marked up its inflation forecasts through the end of 2023. Officials see their preferred measure of price pressures rising 3.4% in 2021 compared with a March projection of 2.4%. The 2022 forecast rose to 2.1% from 2%, and the 2023 estimate was raised to 2.2% from 2.1%.

Consumer-price pressures have proven hotter than expected over the last two months. Labor Department figures showed a 0.8% jump in prices in April and a 0.6% rise in May, marking the two biggest monthly increases since 2009.

Fed Sees Two Rate Hikes by End of 2023, Inches Towards Taper

“As the reopening continues, shifts in demand can be large and rapid, and bottlenecks, hiring difficulties and other constraints could continue to limit how quickly supply can adjust -- raising the possibility that inflation could turn out to be higher and more persistent than we expect,” Powell said.

Labor Department reports on employment published since the last gathering of the FOMC in late April, on the other hand, have disappointed relative to forecasters’ expectations. The U.S. unemployment rate was still elevated at 5.8% in May, with total employment still millions of jobs below pre-pandemic levels.

Even so, the FOMC median projection for unemployment in the fourth quarter of 2021 was unchanged at 4.5%, and the median estimate for the same quarter a year later was marked down to 3.8% from 3.9%. The 2023 forecast was held at 3.5%.

“I am confident that we are on a path to a very strong labor market,” Powell told reporters. “We learned during the course of the last very long expansion, the longest in our history, that labor supply during a long expansion can exceed expectations.”

GDP Forecasts

The U.S. economic recovery is gathering strength as business restrictions lift and social activity increases across the country. Robust demand from consumers and businesses alike has outstripped capacity, leading to bottlenecks in the supply chain, longer lead times and higher prices.

Fed officials have said such “fits and starts” are to be expected given the unprecedented nature of the pandemic and expressed optimism about the outlook for the second half of the year as more Americans get vaccinated.

The FOMC raised its projections for economic growth. Gross domestic product was seen expanding 7% this year, up from a prior projection of 6.5%. It maintained the 2022 expansion forecast at 3.3% and raised the 2023 estimate to 2.4% from March’s 2.2%.

©2021 Bloomberg L.P.

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