Rate Hikes May Come Sooner Than Expected, Fed Says

By Yuval Rosenberg

Rate Hikes May Be Coming Sooner Than
Expected, Fed Says

The Federal Reserve announced Wednesday that it was keeping
interest rates near zero for now but indicated that it may raise
rates sooner than previously expected in response to strong growth
and rising inflationary pressures.

“Progress on vaccinations has reduced the spread of COVID-19 in
the United States,” the Federal Open Market Committee said in a

statement. “Amid this progress and strong policy
support, indicators of economic activity and employment have
strengthened.”

The Fed raised its estimate of economic growth to 7% for
2021, which would be the fastest annual rate since 1984. Growth is
expected to drop off after this year, falling to a still robust
3.3% in 2022 and 2.4% in 2023.

The rapid growth has been accompanied by higher-than-expected
inflation as the economy struggles to get back on its feet, and
central bank officials now see the inflation rate rising to 3.4% by
the end of the year, a full percentage point higher than the
previous estimate in March.

Still, the Fed said it continues to believe that the spike in
inflation is temporary, “largely reflecting transitory factors”
such as supply shortages and labor market dislocations. The
headline inflation rate is projected to drop to 2.1% in 2022 and
2.2% in 2023.

With respect to interest rates, the
projections provided by the Fed indicate that a
majority of FOMC officials now expect to raise the benchmark
short-term rate two times by the end of 2023, to 0.6%. In March,
projections showed interest rates staying near zero into 2024.

Holding steady on support: The FOMC said it remains
committed to purchasing at least $80 billion of Treasury securities
every month, as well as $40 billion in agency
mortgage‑backed securities, with those purchases
continuing “until substantial further progress has been made toward
the Committee's maximum employment and price stability goals.”

At a press conference, Fed Chair Jerome Powell that “policy will
remain highly accommodative” even as the economic numbers improve.
Inflation has been below the 2% target rate for years, Powell said,
and the bank does not want to slam on the brakes just because
inflation climbs above the target for a period of time. An
inflation rate above the target could still be in line with the
bank’s long-term goals, as long as the average is still on
target.

At the same time, the Fed is ready to act if inflation moves
higher than expected over a longer period. “If we saw signs that
the path of inflation or longer-term inflation expectations were
moving materially and persistently beyond levels consistent with
our goal, we'd be prepared to adjust the stance of monetary
policy,” Powell said.

The bottom line: The economy is recovering rapidly but is
not yet out of the woods. While inflation is higher than expected,
the Fed plans to give the economy plenty of room to run rather than
risk a premature tightening.

Number of the Day: 5.3%

Social Security’s cost-of-living adjustment for 2022 could be
5.3%, the highest since 2009, according to the latest
estimate by The Senior Citizens League, a
non-partisan senior group. The estimate, highlighted by
CNBC, reflects rising consumer prices since it is
based on Consumer Price Index data from the Bureau of Labor
Statistics through May. Social Security beneficiaries received a
1.3% increase for 2021. The final adjustment for next year will
depend on the path of the economy in the months ahead and won’t be
known until October. It’s already clear, though, that the
adjustment is likely to be the highest in years.

Yellen Tells Lawmakers Now Is the Time for
‘Ambitious Fiscal Policy’

Treasury Secretary Janet Yellen on Wednesday defended President
Joe Biden’s proposed $6 trillion budget for 2022, telling lawmakers
on the Senate Finance Committee that now is the time to embrace an
“ambitious fiscal policy” to help reverse “destructive forces” like
inequality, declining labor force participation and climate
change.

Yellen said in testimony before the Senate panel that the U.S.
economy is “well on the way” to a strong recovery from the Covid-19
pandemic, but that the private sector does not make enough of the
kinds of investments needed to reverse the nation’s structural
economic challenges. The nation has underinvested in those areas
for 40 years, she said.

“We need to make these investments at some point, and now is
fiscally the most strategic time to make them,” Yellen said. “We
expect the cost of federal debt payments will remain well below
historical levels through the coming decade. We have a window to
invest in ourselves.”

Yellen added that Biden’s budget “is both fiscally strategic and
fiscally responsible,” arguing that the president’s proposed tax
hikes on the wealthy and corporations would both pay for his
spending plans over time and make the tax code fairer. “There are
some tough trade-offs in fiscal policy, but this – a fairer tax
code for a structurally sound economy – is not one of them,” she
said.

Republicans take aim at Biden’s tax and spending plans:
Republicans on the panel criticized Biden’s economic agenda and
warned that the resulting near-term increases in the national debt
could be dangerous. Republicans, and some economists, fear that a
surge of trillions in federal spending could overheat the economy
and drive a longer-term rise in inflation, potentially forcing the
Federal Reserve to raise interest rates.

“The administration’s proposals to increase spending, hit
Americans with higher taxes and strangle the economy with
regulations and red tape is not a path to prosperity,” said Sen.
Mike Crapo (R-ID), the top Republican on the committee. “The
President’s budget envisions deficits of $14.5 trillion over the
next decade, with debt exploding to more than $39 trillion, or 117
percent of GDP, by the end of fiscal year 2031. Such high debt is
risky, especially in the current high inflation environment. … If
inflation expectations become unanchored, which no one can credibly
claim cannot happen, the resulting increased interest rates can
turn federal debt service costs into budget busters.”

Yellen reiterates that inflation will be temporary: The
Treasury Secretary said that the administration was closely
watching inflation and that she still believes that the current
price pressures will dissipate as the pandemic recedes and the
economy returns to normal. “Most economists think the current burst
of inflation we have seen reflects the difficulties of re-opening
an economy that has been shut down,” Yellen said. She acknowledged,
though, that inflation this year will be higher than the 2% rate
the Biden administration projected in February. "We're monitoring
inflation very carefully and take it very seriously. No one wants
to return to the bad high inflation days of the '70s," she
said.

Several Republicans also took issue with the Biden
administration’s proposals to ramp up Internal Revenue Service
funding to increase enforcement and shrink the “tax gap,” the
amount of taxes that goes unpaid, which the administration
estimates will total $74 trillion over the next decade. And they
questioned the administration’s push for a
15% global minimum corporate tax, which the G7
nations agreed to earlier this month. “That’s not a race to the
bottom that we should try to prevent,” Sen. Pat Toomey (R-PA) said.
“That’s a race we ought to be winning.”

Quote of the Day: Biden Says He Hasn’t Seen Details of
Bipartisan Infrastructure Deal

“I honestly haven't seen it. I don't know what the details
are. I know that my chief of staff thinks there's some room, that
there may be a means by which to get this done, and I know that
[Chuck] Schumer and Nancy [Pelosi] have moved forward on a
reconciliation provision as well. So I'm still hoping we can put
together the two bookends here."

– President Biden, in response to a question Wednesday about the
bipartisan infrastructure deal negotiated by 10 senators. Biden has
spent the past week in Europe, meeting with the leaders of the G7
nations and holding a summit meeting today with Russian President
Vladimir Putin. The senators behind the deal are
still working to secure the support of Democratic
and Republican leaders and the White House.

Send your feedback to yrosenberg@thefiscaltimes.com.
And please tell your friends they can
sign up here for their own copy of this
newsletter.

News

Views and Analysis