A “very tight” labor market and unchecked inflation could force the United States Federal Reserve to raise interest rates sooner than expected and begin decreasing its overall asset holdings as a second economic brake, policymakers at the US central bank said last month.

The minutes from the Fed’s Dec. 14-15 policy meeting, which were released on Wednesday and interpreted by markets as decisively hawkish, showed Fed officials evenly concerned about the rate of price increases, which were expected to continue “far into” 2022, as well as global supply bottlenecks.

Those concerns appeared to outweigh the threats posed by the fast-spreading Omicron version of the coronavirus, which some Fed officials saw as likely contributing to inflation pressures but not “fundamentally altering the course of economic recovery in the United States,” at least as of mid-December.

“Participants generally noted that, given their individual outlooks for the economy, the labor market, and inflation, it may become warranted to increase the federal funds rate sooner or at a faster pace than participants had earlier anticipated. Some participants also noted that it could be appropriate to begin to reduce the size of the Federal Reserve’s balance sheet relatively soon after beginning to raise the federal funds rate,” the minutes stated.

The phrase revealed the breadth of the Fed’s recent agreement on the need to combat high inflation – not just by raising borrowing costs, but also by using a second lever to reduce the central bank’s holdings of Treasury bonds and mortgage-backed securities. The Fed’s balance sheet currently stands at $8.8 trillion, with much of it collected during the coronavirus pandemic to keep financial markets stable and long-term interest rates low.

The stock market reacted quickly.

According to CME Group’s FedWatch program, the possibility that the Fed would raise interest rates in March for the first time since the epidemic began has risen to more than 70 per cent.

The threat of the Fed withdrawing from long-term asset markets, along with this, pushed the 10-year Treasury yield to its highest level since April 2021.

The S&P 500 index fell 1.6 percent as the transcript of the Fed’s meeting last month revealed possibly even greater commitment than investors had expected among policymakers to combat inflation. The yield on the 2-year Treasury note, which is the most susceptible to Fed policy predictions, has risen to its highest level since March 2020, when the pandemic-fueled economic catastrophe was in full swing.

“This is news. This is more hawkish than expected,” said David Carter, chief investment officer at Lenox Wealth Advisors in New York.

The minutes provided more details on the Fed’s unexpected policy shift last month, which was implemented to combat inflation that was running at more than twice the central bank’s target of 2%.

Along with expressing their concerns about inflation, officials stated that, despite the fact that the US labor market is still more than 3 million jobs short of its pre-pandemic peak, the economy is rapidly approaching what could be considered maximum employment, given the retirements and other exits from the labor market prompted by the health crisis.

“Participants pointed to a number of signs that the U.S. labor market was very tight, including near-record rates of quits and job vacancies, as well as a notable pickup in wage growth,” the minutes said. “Many participants judged that, if the current pace of improvement continued, labor markets would fast approach maximum employment.”

(Adapted from Reuters.com)