At the latest Federal Open Market Committee (FOMC) meeting, the US Federal Reserve (Fed) announced that it will double the rate at which it reduces monthy asset purchases (QE tapering program), meaning that the process will end by March 2022. The Fed also signaled three rate hikes next year to cope with high-flying inflation while the labor market is approaching full employment.
Such statements by the Fed are as expected by the markets, and suggest that future inflation and economic directions are still manageable, thus helpig bolster market confidence. The Fed will likely attempt to use communications to lead market expectations and avoid sending any signals that are beyond market expectations as the move could trigger volatiliy in the markets. It has been seen that the Fed continues to maintain its cautious views, and it has sent signals that policy rate hikes will be made at a slow pace. The median value of the Fed’s dot plot, which it uses to signal its outlook for the path of interest rates, is expected to increase over the current level of near zero to 0.9 percent by the end of 2022; thereafter, it will shift to 1.6 percent in 2023, and 2.1 percent in 2024. Additionally, the Fed recognizes the impact of the new Omicron variant of COVID-19 on its economic and inflation forecasts to a certain extent. This reflects the Fed’s view that inflation will eventually decline when the demand-supply gap issue has eased, and the unemployment rate may decline to an appropriate level of 3.5 percent during 2022-2024, thus allowing the Fed to gradully increase interest rates later on.
However, close attention must be paid to economic risks stemming from the new Omicron variant, including future inflation and unemployment, as they may affect the Fed’s monetary policy stance, going forward. If the impact of the Omicron variant is more severe than previously estimated, the US economy will likely experience increased risks, and this will in turn threaten its labor market. As a result, the Fed may face challenges in raising interest rates, though it has to weigh between economic risk and price stability. If the impact of the Omicron vaiant is not as severe as previousely expected, and the US economy may be relatively overheated, with the labor market continuing to rebound at a solid pace and inflation continuing to rise, the Fed may be pressured to make more rate hikes than previousely signaled. Therefore, there is a likelihood that the Fed will make more than three rate hikes during 2022. Given this, close monitoring must be made of the Fed’s signals of any change to its monetary stance at the FOMC meeting scheduled for March 2022 prior to the end of the QE tapering program.