Fed Meeting Likely to Signal Possible Policy Shifts

The new forecasts could show officials expecting to raise interest rates sooner than they anticipated in March, when most saw the benchmark federal-funds rate remaining steady through 2023. They are also likely to begin discussing when and how to start scaling back bond purchases.

Fed officials want the economy to get closer to their goals of “maximum employment” and sustained, 2% inflation before reducing the bond purchases. They have said they want to fully achieve those objectives before they raise interest rates.

Since officials’ April meeting, the labor market’s progress has been somewhat slower than they had anticipated. Employers added 837,000 jobs in April and May, leaving total employment 7.6 million jobs shy of pre-pandemic levels.

In contrast, inflation has been hotter than expected as the economy has come roaring back. The Labor Department’s consumer-price index rose 5% in May from a year earlier.

That inflation rate, the highest since 2008, makes the Fed uncomfortable, even if officials believe it reflects mostly temporary factors that should fade later this year. They worry that if inflation exceeds 2% too much or for too long, it might lead businesses and consumers to anticipate more inflation in the future, which can become self-fulfilling. Evidence of rising inflation expectations would likely require the Fed to tighten policy sooner or more aggressively than planned to re-anchor those expectations around 2%.

“We aren’t in the camp that says a sustained inflation problem is a done deal, but we do think that the Fed now needs everything to go right if inflation is to return to the target, as per the March forecasts, by the end of next year,” said Ian Shepherdson, chief economist at Pantheon Macroeconomics, in a note to clients. Unless more workers start returning to the labor force and inflation expectations remain contained, he said, the Fed could raise rates as early as 2022.

The new economic projections, postmeeting statement and Chairman Jerome Powell’s press conference Wednesday will give Fed officials their first opportunity to comment publicly on the latest inflation data and how they affect the policy outlook. The policy makers have been in a self-imposed blackout period—when they refrain from speaking publicly on monetary policy ahead of a policy meeting—since June 5.

In addition to updating their interest-rate expectations, Fed officials’ individual projections will likely show upwardly revised inflation and economic-growth forecasts from March, when their previous estimates were released.

The Fed’s postmeeting policy statement is also likely to undergo changes. In April, they noted “inflation running persistently below” 2%, which is no longer the case.

In every statement since December, officials have said the Fed “will aim to achieve inflation moderately above 2% for some time so that inflation averages 2% over time.” They have said they expect “to maintain an accommodative stance of monetary policy until these outcomes are achieved.”

The Fed hasn’t said how far back in time it will look to decide whether inflation has averaged 2%. Fed officials said as recently as April that they wanted to see the economy make substantial further progress toward their inflation and employment goals before they would begin reducing the bond purchases, a process known as tapering.

Mr. Powell has said the Fed would give markets plenty of advance notice before it begins withdrawing the easy-money policies it put in place last year amid the pandemic.

Among his objectives is to avoid triggering the sort of market turmoil, or “taper tantrum,” that ensued when the Fed announced plans to scale back a similar bond-buying program in 2013.

Rather than rising gradually to reflect the approaching policy shift, 10-year Treasury yields have fallen since the Fed’s April meeting.

Fed officials indicated before the blackout period that they believed the labor market still needed central-bank support. But they also realize that the U.S. economy, powered by trillions of dollars of fiscal stimulus, currently has too much momentum to be knocked off course by the temporary market turmoil that an earlier-than-expected Fed policy shift would spark.

Write to Paul Kiernan at [email protected]