Amid rising inflationary pressures, the Fed could increase the pace of its QE tapering and raise the policy rate much sooner than previously expected. The United States’ inflation rate continues to surge, with the headline inflation rate, gauged by the consumer price index soaring to a new high in almost 40 years at 6.8 percent YoY, in November 2021. Supply chain bottlenecks and labor shortages in the US, which are unlikely to be resolved in the near future, give the impression that the US inflation rate will remain high throughout the forthcoming period. On the other hand, the US labor market continues to experience a robust recovery. Based on these factors, the Fed has been under pressure to reverse its expansionary monetary policy and implement a tightening monetary policy at an accelerated rate. By moving up QE tapering, the reduction in bond purchases is expecteผผผผผผผผผผผผผผผผผผผผผผผผผผผผผผผผผผผผผผผผผผผผผผผผผผผผผผผผผผผผผผผผผผผผผผผผผผผผผd to conclude before June 2023, as originally planned. The Fed may also hike the policy rate sooner than it has previously signalled.
However, the Fed may have to weigh inflationary risk against additional economic risk that could stem from the spread of the Omicron variant of COVID-19 as well as a deceleration in domestic demand, and geopolitical risk emerging from revived tensions between China and the US over Taiwan. Hence, the Fed has to assess multiple risks before it can decide on the appropriate time to raise its policy rate in the upcoming period. Should the Fed increase its policy rate quicker than deemed appropriate, it could create considerable volatility in the financial and capital markets, and further impede the US economic recovery amid this period of uncertainty brought on by the prolonged COVID-19 pandemic. Moreover, it would not help to resolve the issue of supply limitations including labor shortages and congestion at US ports – both of which contribute to higher inflation.
That said, economic projections and the inflation should be monitored. Close attention should also be paid to the Fed’s new ‘Dot Plot’ which will be released at the FOMC meeting on December 14-15, 2021. These projections will serve as an indicator of upcoming trends in monetary policy. KResearch assesses that the Fed could raise its interest rate projections to match the current economic conditions. The Fed ‘Dot Plot’ may also indicate a potential increase in policy rate that could happen sooner than stated in the Fed’s earlier announcement in September 2021. As it stands, there could be at least two policy rate hikes in 2022. Nevertheless, the Fed tends to maintain a cautious view in racheting up its inflation projections to avoid signaling a tightened monetary policy sooner than the market now anticipates – which would generate massive volatility in the financial market.