The Fed’s hawkish stance is usually not met with much fanfare, but a recent article in the Wall Street Journal reported that investors are worried about how sharp interest rate increases could hit their portfolios. In this market climate, it may be time to consider hedging your investments against future volatility.
Chairman of the Federal Reserve, Jerome Powell. The central bank’s decision on Wednesday opened the door to a first rate hike in the spring.
Associated Press photo/Andrew Harnik
The Federal Reserve may be on the verge of making a mistake, but it’s difficult to say which way.
The Federal Reserve laid the groundwork on Wednesday for hiking rates sooner and by a larger amount next year than previously anticipated. Its decision to complete its bond purchases by March opens the door to an initial rate hike in the spring, and its projections now show policymakers expect to raise their overnight rate target range by 0.75 percentage point by the end of next year, whereas they were previously split on whether or not to raise rates at all.
The change is due to two major factors: The first is that the spike in inflation hasn’t been as short-lived as the Fed anticipated, with supply-chain issues continuing, driving up goods costs in particular. The second point is that, despite high labor demand, many individuals have yet to re-enter the workforce. This is raising salaries and, to the degree that businesses are able to pass on their expenses to consumers, this may contribute to total inflation.
One clear concern is that three quarter-point rate hikes over the next year will not be enough to keep inflation under control. Perhaps waves of new coronavirus varieties prevent bottlenecks from clearing, or perhaps individuals continue to delay coming back to work, increasing wage pressures. Higher inflation may become so engrained in consumer expectations that it is difficult to reverse.
In that scenario, the Fed will be forced to keep raising rate expectations, which is particularly concerning for investors since historically, when the Fed has been behind the curve on rates, it has tended to tighten to the point where the economy has stumbled.
The Fed may also run the danger of running out of patience too soon. Recently, there have been signs that supply-chain issues are easing, and the November employment report indicated an increase in the number of persons entering the workforce. Households are unlikely to receive another round of government relief payments in 2022, thereby eliminating a major source of demand. Inflation and the economy may be less hot than the Fed expects.
The best case scenario is that the Fed, with its upcoming reset on Wednesday, gets everything exactly right. The worst-case scenario is if the Omicron variety triggers a surge of Covid-19 cases that cause so much economic harm that hiking rates next spring becomes impossible. Mistakes in Fed policy are a scary potential, but there are far worse situations.
In a Senate hearing, Federal Reserve Chairman Jerome Powell outlined the causes fueling sustained inflation as well as the danger the Omicron variant offers to the economy. Al Drago/Bloomberg News photo
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The print version of the December 16, 2021, was published.