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Dec. 7, 2021, 5:04 p.m. EST

Investors are grappling with how limited the next set of Fed interest rate increases may be

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By Vivien Lou Chen

Ahead of next week’s Federal Reserve policy meeting in Washington, investors are already grappling with what the next U.S. interest rate-hike cycle will look like in years to come, with some pointing to the 2015-2018 campaign as an example of how shallow and short-lived it may turn out to be.The year 2018 was the last time Fed officials were able to deliver multiple rate increases in one year and, back then, the U.S. was still in its longest economic expansion on record. By 2019, policy makers were fretting about the risks of a recession and, instead of hiking even further, they delivered three so-called “preemptive” rate cuts to avoid a downturn. The U.S. economy then started contracting in February 2020 as a result of the spread of the coronavirus. Much of the attention leading up to the Federal Open Market Committee’s Dec. 14-15 meeting in Washington will now, of course, be on the efforts to pull back from extraordinary pandemic-era monetary stimulus. Beyond how quickly the central bank will taper monthly bond purchases and the timing of the first rate hike, the next obvious question for investors is where the fed funds rate target will end up, considering the U.S. is now in a period of persistently higher inflation that likely requires higher rates. “There seems to be a notable divide between those viewing the prior cycle as a guide for what’s practically achievable and the camp anticipating the policy response will ultimately need to be more robust,” BMO Capital Markets analysts Ian Lyngen and Ben Jeffery wrote in a note Tuesday.“The former group is assuming that the Fed’s ‘longer run’ projection of 2.50% is too ambitious, while the latter contingent anticipates the realities of the upside risks of inflation will necessitate a 3-4% terminal” rate, they said. W<STRONG>ant intel on all the news moving markets? Sign up for our daily Need to Know newsletter. Use <INTERNET LOCATION="EXTERNAL" URL=";mod=article_inline&amp;mod=article_inline">this link to subscribe</INTERNET>.</STRONG> During the Fed’s last rate-hiking cycle, policy makers gingerly tried to lift the fed funds rate target up from a level of zero to 0.25%, where it had been held since December 2008. Officials managed to raise the target just once, by 25 basis points, to 0.25%-0.5% in December 2015. Then, they waited a full year before lifting rates again, by another 25 basis points, to 0.5%-0.75% in December 2016. It was not until 2017 — or more than eight years after the fed funds rate target first fell to around zero — that Fed officials felt confident enough to hike rates by more than just once: They did so three times that year. Then, in 2018, policy makers hiked rates four more times , taking the fed funds rate target to 2.25%-2.5%.But instead of raising rates even further in 2019, they backed off and preemptively lowered borrowing costs three times, taking the fed funds rate target back down to 1.5%-1.75%. The target was then slashed even further, down to around zero in March 2020, as the COVID-19 coronavirus turned into a global pandemic. Now, analysts say, both the economic recovery and financial markets appear to be in a somewhat fragile state heading into year-end when illiquidity can lead to big swings in assets, such as government bonds. FHN Financial is just one of the firms that sees the fed funds rate target as likely to be stuck below 1.25% through December 2024, implying the Fed hikes only four times by 25 basis points each, versus the 1.8% median forecast of FOMC officials by then. Fed officials’ long-run median forecast for the target is 2.5%, which is the highest level the policy rate managed to reach during the last rate-hike campaign.

“People think the Fed is being forced to act in the face of higher inflation, and maybe the economy doesn’t have the strength to handle meaningful tightening,” said Tom Graff, head of fixed income for Brown Advisory in Baltimore. “A lot of things can happen next year, with the Fed tapering or hiking rates just once. But if it’s obvious the economy is slowing after this, maybe the Fed goes quickly to the sidelines or maybe it cuts rates.”On Tuesday, 2-year /zigman2/quotes/211347045/realtime BX:TMUBMUSD02Y -0.46% , 10-year /zigman2/quotes/211347051/realtime BX:TMUBMUSD10Y -0.69% and 30- year Treasury yields /zigman2/quotes/211347052/realtime BX:TMUBMUSD30Y -0.44% all edged up on easing fears about the omicron variant of coronavirus. Dow industrials /zigman2/quotes/210598065/realtime DJIA +0.78% surged nearly 500 points, and the Nasdaq Composite Index /zigman2/quotes/210598365/realtime COMP +1.90% rallied 3%.

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