The Right Move

By: Dr. M. Ray Perryman
Published in syndication February 02, 2022

With inflation spiking and job openings far outnumbering unemployed persons, it is little surprise that the Federal Reserve is signaling a change in the game plan. By clearly communicating the thought process and the likely approach, the potential for disruptive surprises has been reduced.

The most recent statement from the Federal Open Market Committee (FOMC) notes that indicators of economic activity and employment have continued to strengthen, sectors most adversely affected by the pandemic have markedly improved, and job gains have been solid. The recent Omicron-driven increase in COVID-19 cases was also noted. In fact, the release observed that the "path of the economy continues to depend on the course of the virus." No kidding?!

The FOMC noted that supply and demand imbalances related to the pandemic and the subsequent reopening have contributed to elevated inflation. Given levels well over the 2% target and the strength of the labor market, the Committee indicated that it likely will soon be appropriate to raise the target range for the federal funds rate. In addition, the monthly pace of asset purchases will be reduced and ended in early March, meaning that the FOMC is slowing and then stopping this channel of injecting liquidity into the system (when the Fed buys bonds, it injects new money into the economy).

In addition, the Federal Reserve will be slowing purchases of mortgage-backed securities and is setting the stage for reducing its multi-trillion-dollar holdings of such assets. When the Fed stops buying these securities in volume (as it did early in the pandemic to stabilize things), the natural outcome is an increase in mortgage rates. While the bump is small so far, it will modestly increase the cost of buying a house.

On balance, the Fed sees that inflation is a problem and that the labor market is tight. At the same time, there are risks to the economy such as new variants. The target range for the federal funds rate was therefore maintained, and purchases and holdings of securities will continue (though some will be winding down). Going forward, policy will be driven by a wide range of information including public health, labor market conditions, inflation pressure expectations, supply chain status, and financial and international developments.

It's clearly time for some of the expansive monetary policy initiatives needed to keep the economy functional during the pandemic to come to a carefully planned conclusion. Some analysts are complaining that it is too little, too late, while financial markets always seem to want low interest rates. To all of those critics on both sides, I would say "chill." This is the right move for the moment, and there's always the ability to adjust as conditions warrant. Stay safe!