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Fed Minutes Point to Possible Rate Increase in March

Federal Reserve officials at their meeting last month looked at a faster schedule for raising interest rates this year, possibly as soon as March, amid greater unease with inflation rising.

And the minutes of their December 14-15 meeting, which was released on Wednesday, showed that officials believe that rising inflation and a very tight labor market may require short-term interest rates to be raised “sooner or faster than participants expected earlier.”

The minutes also said that some officials believe the Fed should start reducing its $8.76 trillion portfolio of bonds and other assets relatively soon after starting to raise interest rates. Investors will see the move as another way for the Federal Reserve to tighten financial conditions to cool the economy.

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Stocks turned sharply lower after the minutes were released on Wednesday afternoon. The leading Dow Jones Industrial Average fell 1.1%, while the tech-heavy Nasdaq Composite Index lost 3.3%.

Meanwhile, government bond yields rose on Wednesday. After the minutes were released, trading in the interest rate futures markets implied that there was a roughly two-thirds chance of the Fed raising rates in March, according to CME Group.

Julia Coronado, founder of economic advisory firm MacroPolicy Perspectives, said the minutes prompted her to raise her forecast for a price increase to start in March, rather than June.

“The Fed is on track for a slide in March,” said Neil Dutta, an economist at research firm Renaissance Macro. “It’s hard to see what’s going to hold them back.”

Most central bank officials, in forecasts released after last month’s meeting, identified three increases of at least a quarter of a percentage point this year. In September, about half of the group thought rate increases might wait until 2023.

For months, Fed leaders have stuck to the view that higher price pressures in 2021 were primarily caused by supply chain bottlenecks and would recede on their own. But Fed Chairman Jerome Powell signaled before the meeting much less conviction in those expectations, and other officials last month widely shared his views.

“While participants generally continued to expect inflation to decline significantly over the course of 2022 as supply constraints ease, nearly all of them reported significantly revising their 2022 inflation forecasts, and many did so for 2023 as well,” the minutes said.

One direct sign of their concerns can be seen in the plans they agreed to at that meeting to scale back or reduce their asset purchases faster. The program is now on track to end in March instead of June.

The Federal Reserve says it will speed up the process of ending its bond-buying program, the central bank’s biggest move to reverse stimulus in the era of the pandemic. Here’s how tapering off works and why it’s sending markets over the edge. Photo caption: Adele Morgan/WSJ

The Fed wants to end its bond-buying program, a form of economic stimulus, before it raises short-term interest rates to curb inflation. “The primary objective of accelerating tapering is … so the March meeting could be a live meeting” to raise interest rates, Fed Governor Christopher Waller said in comments on Dec. 17. “That was the goal.”

In their statement after the meeting, officials described their goal of moderate inflation above their 2% target as having been met, one of the two main criteria set by the central bank to justify raising interest rates.

The minutes showed that most officials believe they can “rapidly close” to their second goal of achieving labor market conditions compatible with maximum employment if recent employment progress continues.

Several officials said last month that rising inflation pressures may force the Fed to raise interest rates before the employment target is met, and some officials believe it has already been met, according to meeting minutes.

The shift is the latest sign of how the acceleration and expansion of inflationary pressures, amid a tight labor market, has reshaped officials’ economic expectations and policy planning.

Fed officials’ decision to move away from gas more quickly reflects a shift in calculus about the potential for increased demand to raise prices — such as wages and rents — even after supply chain bottlenecks and shortages of items such as cars recede.

Rising demand for goods, supply chain disruptions and various shortages pushed 12-month inflation to its highest readings in decades. Core consumer prices, which exclude volatile food and energy categories, rose 4.7% in November from a year earlier, according to the Federal Reserve’s preferred metric. This is well above the Fed’s 2% target and officials’ stated desire to keep inflation a little higher than that target.

“There is a real danger now, I think, that inflation could be more persistent … and …

While officials last month referred to the Omicron variant of the coronavirus as a risk, minutes indicate that officials do not see it as a serious headwind for the economy.

The minutes also provided more detail about officials’ initial discussions last month about how and when to reduce their $8.76 trillion Treasury and mortgage portfolio, which has doubled in size amid efforts to stabilize the economy over the past two years.

Bond-buying programs stimulate the economy by lowering long-term interest rates, encouraging consumers and businesses to borrow and spend. In theory, this should also stimulate financial markets by driving investors into stocks, corporate bonds and other assets.

Once the Fed stops buying assets, it can keep holdings steady by reinvesting maturing bond proceeds into new contracts, which should have an economic neutral effect. Alternatively, the Fed could allow its holdings to shrink by allowing bonds to mature, or fade, which would be a form of policy tightening.

In the past decade, the Fed held holdings steady for about two years after it raised interest rates for the first time before gradually shrinking its holdings in 2017. Most officials thought last month that they should start cutting back their holdings sooner this time because the economy is stronger, Inflation is high and the minutes said the asset portfolio is much larger.

Officials also thought it would be appropriate to shrink the asset portfolio faster than they did at the end of the last decade.

Minutes suggest that shrinking the Fed’s asset portfolio “will be a more prominent feature of the tightening than last time,” Ms Coronado said.

Fed officials could resume deliberations on their portfolio runoff tactics at their next meeting, January 25-26.

write to Nick Timiraos and nick.timiraos@wsj.com

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