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The Fed: Fed, alert to risks of higher inflation, now sees two interest rate hikes in 2023

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Alert to the risks that inflation may continue to increase, the Federal Reserve on Wednesday said it might hike interest rates earlier than it had previously expected, penciling in two rate hikes in 2023.

In its statement though, the Fed stuck to its guns and said the recent burst of inflation would be transitory.

But time and again during his press conference, Fed Chairman Jerome Powell stressed he and his colleagues were attuned to the risk that inflation could rise faster and last longer than expected.

The Fed forecast that inflation would move up to 3% annual rate this year but would then drop sharply in 2022. Even this forecast builds in slower inflation coming months, economists noted.

Last Thursday’s consumer-price index report from the U.S. Labor Department showed that the cost of living surged in May and drove the pace of inflation to a 13-year high of 5%, reflecting a broad increase in prices confronting Americans

In an outcome that was more hawkish than expected, the Fed’s dot plot chart showed 11 of 18 officials expect at least two rate hikes in 2023. In March, only seven expected one hike. Seven officials now see the first hike next year, up from four in March.

“After dismissing rising inflation and inflation expectations for the past three months…it feels like the FOMC just put their hands back on the wheel,” wrote Aneta Markowska, economist at Jefferies, in a note to clients.

Just as importantly, Powell announced the Fed held its first discussion about slowing down its bond purchases.

The Fed is buying $80 billion of Treasurys and $40 billion of mortgage-backed securities each month, along with keeping its benchmark interest rate pinned close to zero, in a concerted effort to keep financial markets stable and support the economy.

The Fed has said it wanted to see “substantial further progress” before slowing down the bond purchases — the first step of pulling back all the support for the economy.

“Taper discussions will get more serious at the July meeting,” Markowska said.

Many economists, including former U.S. Treasury Secretary Larry Summers, say the Fed needs to rethink its policy given the two massive fiscal stimulus passed by Congress since December.

U.S. stocks fell sharply after the Fed decision but recovered somewhat with the Dow Jones Industrial Average
DJIA,
-0.77%

down 265 points at the close.

The yield on the 10-year Treasury note
TMUBMUSD10Y,
1.579%

rose to 1.56% from 1.49% on Tuesday.

Joe Lavorgna, chief economist for the Americas at Natixis downplayed the bond market reaction.

“The market basically took everything Powell said in stride,” Lavorgna said in a phone interview. Before today, the bond market already had one rate hike priced into 2023, he noted.

In a technical adjustment, the Fed raised the interest rate it pays on excess reserves, to 0.15% from 0.10%. The tweak is designed to keep the Fed’s benchmark federal funds rate within its target range. Trading in markets had been pulling that rate lower.

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