The Federal Reserve opted to keep interest rates steady Wednesday, but drastically raised its forecast for inflation and shifted up the timeline for a rate hike.
The Dow Jones Industrial Average, which had been down by around 146 points, fell another 150 points after the announcement, which came at the end of the Fed's two-day monetary policymaking meeting.
“This is not what the market expected,” James McCann, deputy chief economist at Aberdeen Standard Investments, told CNBC. “The Fed is now signaling that rates will need to rise sooner and faster, with their forecast suggesting two hikes in 2023. This change in stance jars a little with the Fed’s recent claims that the recent spike in inflation is temporary.”
Wall Street and other market participants have been closely watching the Fed for its latest forecast on inflation, and for any sign that the central bank is considering starting talks about pulling back on the easy money policies it implemented as part of its response to the pandemic. The Fed's "cheap money" strategy has been widely viewed as the catalyst for Wall Street's series of record highs over the past year.
In their post-meeting statement, Fed officials acknowledged rising inflation, hiking their expectation that inflation will hit 3.4 percent, up from a March projection of 2.4 percent. The statement noted that this largely reflects “transitory factors" stemming from a "greater than anticipated" impact from bottlenecks in the supply chain.
In a significant shift, a number of Fed officials indicated that two rate hikes could come as soon as 2023. That is a departure from March economic projections, which saw no change in the benchmark interest rate before 2024. The Fed's lending rate stands at 0 percent to 0.25 percent.
"This is an extraordinarily unusual time, and we really don't have a template or any experience in a situation like this," Federal Reserve Chairman Jerome Powell said at a news conference after the meeting.
With regard to inflation, Powell cited the record high cost of lumber and used cars as examples of shortages that were creating such activity, which he said "would reverse over time."
"These very specific things that are driving up inflation will be temporary," he said. "High inflation readings will start to abate. There's no reason for supply and demand to be out of whack."
In remarks before Congress and in other economic forums, Powell has reiterated his commitment to the Fed's accommodative policy stance, emphasizing that the central bank is open to seeing inflation run slightly above its 2 percent target for a period of time — as long as that inflation remains "transitory."
Michael Feroli, chief U.S. economist at JPMorgan Chase, said he expected Fed officials to signal a rate increase as early as 2023.
For now, the Fed is determined to "keep the pump primed until employment is all the way back to pre-pandemic levels," said Brad McMillan, chief investment officer for Commonwealth Financial Network.
The current labor market shortage has forced some companies to raise wages, triggering price increases in some cases. While the Fed could raise the interest rate to rein in that inflation, that would have a negative impact on the labor market, as companies tighten hiring to keep costs down. The latest monthly jobs report shows an unemployment rate of 5.8 percent — higher than pre-pandemic levels, which were hovering at a half-century low of around 3.5 percent.
Powell reiterated that employment remains the cornerstone of the Fed's work, saying "rate increases are not the focus of the committee."
He noted the slew of retirements that have changed the shape of the labor force, but said he expected to see a "very strong labor market very quickly," citing the large pool of job seekers and the reopening of schools and child care centers in the fall, which should enable workers who are not currently participating in the labor force to return to work. He also encouraged people to get vaccinated, since that would diminish concerns about contracting the virus at work.
Powell, whose four-year tenure as chair ends in February, has repeatedly clarified that he would give plenty of notice before the central bank starts to withdraw its crisis-era support — ostensibly to prevent any “taper tantrum,” when markets were thrown into turmoil in 2013 after the Fed said it intended to scale back its bond purchasing.
The Fed's annual symposium in August in Jackson Hole, Wyoming, is widely expected to be the moment when Fed officials begin to discuss in earnest the timeline for winding down its $120 billion monthly bond buying.