FED SIGNALS FASTER PACE OF RATE INCREASES, LIKELY BOND RUNOFF / THE WALL STREET JOURNAL

Fed Signals Faster Pace of Rate Increases, Likely Bond Runoff

Minutes show central bank officials in March spelled out plan for shrinking $9 trillion asset portfolio next month to help cool inflation

By Nick Timiraos

Investors in interest-rate futures markets now anticipate that the Federal Reserve under Jerome Powell will raise rates by a half-percentage point in May./ PHOTO: SAMUEL CORUM/GETTY IMAGES

Federal Reserve officials signaled they could raise rates by a half-percentage point at their meeting early next month and begin reducing their $9 trillion asset portfolio as part of their most aggressive effort in more than two decades to curb price pressures.

Minutes from the Fed’s March 15-16 meeting, released Wednesday, showed that many officials last month were prepared to raise rates by a half-point but opted for a smaller, quarter-point increase because of concern over the fallout from Russia’s invasion of Ukraine.

Stocks fell and bond yields rose in the midst of expectations of a more aggressive Fed policy tightening process than previously anticipated. 

The yield on the benchmark 10-year Treasury note, which rises when bond prices fall, climbed to 2.606%, a three-year high, from 2.554% on Tuesday and 2.409% on Monday. 

The Nasdaq Composite dropped 2.2%, while the S&P 500 fell 1% and the Dow Jones Industrial Average was down 0.4%.

Officials including Fed governor Lael Brainard are underscoring the importance of slowing inflation. / PHOTO: AL DRAGO/BLOOMBERG NEWS

Officials last month approved their first interest rate increase in more than three years, raising their benchmark rate to a range between 0.25% and 0.5%. 

They also penciled in a series of additional rate increases this year to take rates closer to 2%, with inflation having surged to a four-decade high.

“Many participants noted that one or more [half-percentage-point] increases in the target range could be appropriate at future meetings, particularly if inflation pressures remained elevated or intensified,” the minutes said.

The minutes revealed for the first time how officials expect to shrink their asset holdings much faster than they did last decade, which would serve as another key tool for tightening monetary policy. 

Officials neared agreement on a plan that, after a roughly three-month ramp-up, would allow up to $95 billion in securities to mature every month without being replaced.

The Fed’s plans have sent tremors through the mortgage market, where the average 30-year fixed-rate mortgage rose last week to 4.9%, the highest rate since late 2018, according to the Mortgage Bankers Association.

In the three weeks since they last met, many Fed officials have indicated that they could support raising rates by a half-percentage point instead of the traditional quarter-point at their next meeting. 

The Fed hasn’t raised rates at consecutive policy meetings since 2006 and hasn’t raised rates by a half-point since 2000.

The Federal Reserve's main tool for managing the economy is to change the federal-funds rate, which can affect not only borrowing costs for consumers but also shape broader decisions by companies such as how many people to hire. 

Investors in interest-rate futures markets now anticipate half-point increases at the Fed’s next meeting, May 3-4, and at the following gathering, in June.

On Tuesday, Fed governor Lael Brainard, who is awaiting Senate confirmation to serve as the Fed’s vice chairwoman and has previously been an influential voice warning against prematurely pulling back stimulus, underscored in a speech the importance of reducing high inflation.

Ellen Meade, a former Fed economist who is now a policy consultant, said that based on those remarks there is no reason not to expect a half-point increase. 

“It would have been an opportunity to push back at this point in time,” Ms. Meade said. 

“She really laid out the progressive case for why inflation fighting needs to be front and center.”

Consumer prices rose 6.4% in February from a year earlier, according to the Fed’s preferred gauge, the Commerce Department’s personal-consumption expenditures price index. 

Core prices, which exclude food and energy, climbed 5.4%. 

Those readings were the highest in around four decades.

Fed officials a year ago described higher inflation as transitory. 

They backed away from that characterization last fall, as the labor market healed rapidly and price pressures broadened to a range of goods and, more important, labor-intensive services.

Yields on short- to medium-term Treasurys recently logged their biggest quarterly jumps in decades. / PHOTO: TING SHEN FOR THE WALL STREET JOURNAL

Still, as recently as January, the Fed had expected inflation to diminish this spring as supply-chain bottlenecks improved. 

The war in Ukraine and potential lockdowns in China to deal with more-contagious variants of the coronavirus have ended any expectation of near-term relief from improving supply chains.

“That story has already fallen apart,” Fed Chairman Jerome Powell said March 21. 

“To the extent it continues to fall apart, my colleagues and I may well reach the conclusion we’ll need to move more quickly. 

And if so, we’ll do so.”

The central bank is still counting on inflation slowing later this year as supply-chain problems ease and as more workers return to labor markets. 

But unlike last year, Mr. Powell said the central bank could no longer set policy by forecasting that such relief would materialize.

“As we set policy, we will be looking to actual progress on these issues and not assuming significant near-term supply-side relief,” he said.

On the Fed’s asset portfolio, sometimes called a balance sheet, the minutes said officials agreed that they were prepared to start shrinking the holdings as soon as at their May meeting.

The Fed bought nearly $1.5 trillion combined in government debt in March and April 2020 to prevent a broader financial meltdown and then continued to buy $120 billion a month in Treasury and mortgage-backed securities after that to provide additional stimulus to the economy by lowering long-term interest rates.

The Fed began reducing the purchases last fall and phased them out one month ago. 

Since then, it has been reinvesting the proceeds of maturing securities into new ones.

Officials agreed last month to follow a template similar to the one they used when they shrank their asset holdings between late 2017 and mid-2019, in which they allowed a fixed amount of securities to run off the portfolio every month without being reinvested.

The minutes showed officials discussed allowing up to $60 billion in Treasurys and $35 billion in mortgage bonds to mature every month. 

That would allow the portfolio to run off considerably faster this time than last decade, when it shrank by up to $50 billion every month.

Because higher mortgage rates are likely to lead to slower reductions in loan redemptions as refinancing plummets, officials also discussed plans to actively sell mortgage-backed securities at a later date to more quickly return their holdings to an all-Treasurys portfolio.

At a news conference last month, Mr. Powell said the portfolio runoff might provide the equivalent of another quarter-percentage point rate increase this year.

Fed officials face a difficult balancing act because they are attempting to prevent demand from strengthening further, and they could eventually seek to deliberately reduce economic growth to slow inflation. 

But it takes time for their policy steps to take effect, creating a risk that they will cause a recession.

Already, the Fed’s moves are rippling through markets. 

U.S. bonds had their worst quarter in more than 40 years during the January-to-March quarter. 

Yields on short- to medium-term Treasurys logged their biggest quarterly jumps in decades.

The housing market could be an early case study of the Fed’s rapid pivot. 

Rising interest rates rob buyers of their purchasing power. 

A general rule of thumb holds that a one-percentage-point rise in interest rates is equivalent to a 10% increase in the cost of purchasing a home.

In Las Vegas, there were 2,000 homes listed for sale without any offer at the end of March, a 13% increase in such listings from the same time last year, according to a report from a local real-estate association released Wednesday.