The Fed Meets Amid Faster Inflation and Prepares to React

Federal Reserve officials, worried about rising costs and buoyed by a healing labor market, are pivoting from bolstering the economic recovery to more quickly withdrawing the support that has aided the economy since the pandemic began.

The policymakers, who meet this week for their final gathering of 2021, are widely expected to outline a faster end to their bond-buying campaign and will telegraph how aggressively they expect to raise rates from rock-bottom next year.

The potential for major policy signals at the Fed’s meeting, which concludes at 2 p.m. on Wednesday, will make it one of the most closely watched of the pandemic era.

Officials took their first step toward weaning the economy off the central bank’s support in November, when they said they would begin to slow a large-scale bond buying program that had been in place since early in the pandemic to keep money flowing around markets and support the economy. In the weeks since the Fed’s last meeting, fresh data has showed that consumer prices are climbing at the fastest pace in nearly 40 years and the unemployment rate has fallen to 4.2 percent, far below its pandemic peak.

Given inflation and growth trends, Fed officials signaled clearly that they would discuss withdrawing support more quickly at this gathering, and economists think officials will signal a plan to taper off bond purchases so that the buying will stop altogether in March.

Policymakers will also provide their latest thinking on the path for interest rates in their updated quarterly economic projections, and could pencil in two or three increases next year. When they last released the projections in September, officials were split on whether they would raise rates at all in 2022. Lifting the federal funds rate is arguably the Fed’s most powerful tool for pushing back on inflation, because it would slow demand and economic growth by percolating through the rest of the economy, lifting borrowing costs on mortgages, business loans and auto debt.

In late November, Jerome H. Powell, the Fed chair, set the stage for the central bank’s shift from an economy-stoking stance to one that is more focused on keeping inflation under control.

“At this point, the economy is very strong, and inflationary pressures are high, and it is therefore appropriate in my view to consider wrapping up the taper of our asset purchases, which we actually announced at our November meeting, perhaps a few months sooner,” Mr. Powell said during congressional testimony on Nov. 30.

The Fed chair is expected to further explain during a post-meeting news conference on Wednesday how he is thinking about the central bank’s policy stance as it confronts rapid inflation and an uncertain economic path at a time when the virus shows no signs of abating and a new variant, Omicron, complicates the outlook.

The Fed spent much of 2021 tiptoeing away from full-blast economic support, hoping to remove stimulus gradually enough that the job market would heal fully and quickly. But gradualism has given way to wariness in recent weeks, partly thanks to a new series of data points showing that inflation is still high and might stay elevated for some time.

Central bankers knew that prices would climb quickly in early 2021 as the economy recovered from the depths of the pandemic, but the increases have been strikingly broad-based and long-lasting. The gains are broadening beyond pandemic-sensitive goods and into rent and some services, and both wages and inflation expectations are picking up. Policymakers have increasingly questioned the wisdom of adding juice to the economy with each passing month.

“They’re realizing that they need to stop pouring gasoline on the fire,” said Gennadiy Goldberg, a rates strategist at T.D. Securities.

The Fed has two key jobs: keeping prices stable and fostering maximum employment. Progress on the second goal has also been notable in recent months. The unemployment rate has dropped sharply, falling to 4.2 percent in November and improving faster than Fed officials or most economist expected.

Even so, about four million jobs are still missing compared to before the pandemic. Some of those people may have retired, but others are expected to return to the job search once health concerns and pandemic-related child-care problems become less pronounced. Many Fed officials had been hoping to keep their policies very accommodative as those people came back.

But inflation is forcing policymakers to balance their job market ambitions with their goal of keeping price gains under control. While an unhealed job market is bad for American households, so too are high and unpredictable price increases that chip away at paychecks and make it hard for businesses to plan. Plus, if the Fed waits too long to react to inflation, the fear is that they might have to lift rates sharply to bring it to heel, setting off a new recession.

“We have to balance those two goals when they are in tension as they are right now,” Mr. Powell said in testimony on Dec. 1. “But I assure you we will use our tools to make sure that this high inflation that we are experiencing does not become entrenched.”

The Biden administration announced in late November that it would reappoint Mr. Powell as Fed chair, which may have also given Mr. Powell a renewed mandate to lay out a plan to manage the risks around inflation and might explain some of the Fed’s sudden and notable pivot toward focusing more intently on inflation, said Krishna Guha, head of the global policy central bank strategy team at Evercore ISI.

If Mr. Powell were leaving the central bank early next year when his term expires, it might have been tough for him to signal a plan for the future that his successor would have been stuck executing.

Plus, “there is pressure from both sides of the aisle for the Fed to bring inflation under control,” Mr. Guha said. But he think the political element of the shift could be exaggerated; economic fundamentals also explain it.

While many Fed officials say they still expect high inflation to fade, plenty of signs suggest it is at risk of remaining too high for too long. Businesses report that they are raising wages or setting aside money as they prepare to pay more. Companies — from dollar stores to pizza shops — are lifting prices and finding that consumers accept the change.

Even companies taking a cautious approach to lifting prices express uncertainty about how long it will take to clear the supply chain snarls that are pushing up prices for inputs like food commodities and imported goods.

“I think we’re living in elevated time of everything, right?” Randy Garutti, chief executive officer of Shake Shack, said at an investor conference early this month. “That will moderate. I can’t tell you when, I don’t know if it will be next year ’23 or ’24, or which product it will be? That’s unclear.”

Fed officials are quick to acknowledge that the supply snarls seem likely to last into next year, and they seem to view the new coronavirus variant — about which much is still unknown — as something with the potential to prevent tortured supply routes from returning to normal.

As they wrestle with the crosscurrents, Wall Street is debating how quickly the Fed might move to push rates higher next near, and will closely watch how many rate increases officials pencil into their fresh economic projections this week for any hint at the trajectory.

“We think it’s a close call between two or three” estimated increases, J.P. Morgan economists wrote in a preview note, noting that they think three are more likely. They expect the Fed to first raise rates in June 2022, then lift them again every three months.

The plan won’t necessarily be to try to constrain the economy by withdrawing support so rapidly that Fed policy becomes a big drag on growth — the equivalent of slamming the brakes. Instead, it will be to stop helping the economy so much, said Diane Swonk, chief economist at Grant Thornton LLP.

“The Fed is going to take their foot off the gas pedal,” she said. The new development at this meeting is that the stimulus deceleration will be happening “even faster.”