At the conclusion of its December policy meeting, the Federal Reserve announced changes to its outlook and projections that move monetary policy further away from the accommodative stance that has supported the economic rebound from the 2020 recession. This pivot toward tighter policy is a direct result of ongoing, elevated inflation data.
Today’s announcement makes several changes to both the Fed’s economic outlook and its implied monetary policy path:
- Acceleration of tapering of purchases of mortgage-backed securities and Treasuries
- The central bank will double the pace of tapering with an anticipated conclusion of bond purchases in March 2022
- Retirement of “transitory” inflation expectations
- The Fed’s outlook notes that supply-demand imbalances are contributing to “elevated levels of inflation”
- The Fed’s economic projections increased its estimate for 2021 inflation (under the core PCE measure) from 3.7% to 4.4%
- As an indication that inflation will persist well into 2022, the projection for inflation next year increased from 2.3% to 2.7%
- Higher interest rates sooner
- The Fed did not announce a change in the federal funds target rate today
- However, today’s announcement/outlook suggests three 25 basis point rate hikes in 2022 and three more in 2023
This implied tightening is consistent with our existing forecast of a 2% 10-year Treasury rate near the end of 2022. This higher rate also implies the 30-year mortgage rate rising to somewhat higher than 3.6% by the end of next year.
It is important to note that there is not a direct connection between federal fund rate hikes and changes in long-term interest rates. Indeed, during the last tightening cycle, the federal funds target rate increased from November 2015 (with a top rate of just 0.25%) to November 2018 (2.5%), a 225 basis point expansion. However, during this time mortgage interest rates increased by a proportionately smaller amount, rising from approximately 3.9% to just under 4.9%.
Nonetheless, today’s policy pivot, in response to increased inflation data and inflation expectations, will yield higher interest rates in 2022 due to tighter monetary policy. This change will reduce housing affordability and again emphasizes the need for policymakers to enact solutions to fix the nation’s supply-chains.