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Federal Reserve to Raise Interest Rates in March and Sell Bonds

  • The president of the Fed, Jerome Powell, gave clues about the expected rise in interest rates. The Fed expects that rate increases won’t affect employment levels.
  • Investors are concerned about the scope of the rise in interest rates.
  • At the end of the year, the rate is expected to be at 1%, up from near-zero levels, where it is now.

US Federal Reserve Chairman, Jerome Powell, said on Wednesday that asset purchases will likely end in March. It is also likely that the bank will start selling bonds after raising the interest rate. The first increase is estimated at a quarter of a percentage point.

In a document published by the US central bank, the policy to be followed this year was outlined. The bank announced that it will begin to significantly reduce bond holdings on its balance sheet, although it did not specify when.

To deal with the turmoil in financial markets and try to stem raging inflation, the Fed sent a pretty clear message that in March it might raise interest rates for the first time in more than three years.

The announcement of a tightening of the bank’s monetary policy, which in recent times has remained very flexible, did not come as a surprise to anyone. The Fed’s policymaking group indicated that an increase in the reference rate for short-term loans is very likely.

Main Stock Indices Fell

If the rate rises a quarter of a percentage point as expected, it would be the first rate hike in three years. In his statements to the press, Powell pointed out that the body has a very wide margin of action.

"I think there’s quite a bit of room to raise interest rates without threatening the labor market," said the Fed chairman, after the meeting of the Federal Open Market Committee, according to CNBC.

Following Jerome Powell’s statements, the averages of the main stock market indices, which had risen sharply during the day, fell again. There is a lot of concern and agitation in the markets about the decisions that the Fed will make in the coming months.

Inflation in the US has reached 40-year records. Although it is considered a fact that the Fed has to tighten its loose monetary policy to stop the price escalation, investors are worried that interest rates will rise more than expected.

Rates Will Rise, but It Is Not Known When or How Much

The statement issued by the Fed at the conclusion of the meeting of the Federal Open Market Committee (FOMC), did not indicate when interest rates will rise. But it is expected to come after the March meeting.

"With inflation well above 2 percent and a strong labor market, the Committee expects it will soon be appropriate to raise the target range for the federal funds rate," the statement said.

The committee reported that the monthly bond purchase for February will be only $30 billion. Following this announcement, Wall Street analysts expect the pandemic financial support program to end in March.

Similarly, the market expects the Fed to finally approve the announced rate hike. The committee also did not specify when the bond holdings will begin to be reduced, which, according to the body’s balance, already add up to almost $9 billion.

The committee’s statement only mentioned “principles for reducing the size of the balance sheet.” The Fed is believed to have been preparing since last year to “significantly reduce” the volume of assets it holds.

“The Fed’s announcement that it will ‘soon be appropriate’ to raise interest rates is a clear sign that a March rate hike is coming,” said Capital Economics senior US economist Michael Pearce.

He added:

"The Fed’s plans to begin running down its balance sheet once rates begin to rise suggests an announcement on that could also come as soon as the next meeting, which would be slightly more hawkish than we expected."

On the Flipside

  • An increase in the interest rate implies at the same time the increase in the cost of the mega-debt acquired by the US to face the pandemic. Perhaps that is why the Fed has been postponing the decision?
  • Powell and other Fed officials have said for months that inflation was transitory. But, the truth is that it increased 7% year-on-year.

Why You Should Care

  • Investors on Wednesday expected the Fed to make the first announcement of interest rate hikes. There are expected to be three increases of 25 basis points this year, FOMC officials said in December.
  • Traders expect the rate to be around 1% by the end of the year. It is currently at a level close to zero.
  • If inflation does not slow down, it is likely that the agency will have to assume a more aggressive monetary policy.

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