March 24, 2023
The Federal Reserve (Fed) recently raised the fed funds rate again by 0.25%, pushing the upper bound to 5.00%. Financial conditions were stable enough for the Federal Open Market Committee (FOMC) to release updated projections, unlike the Fed’s decision back in March 2020 to delay updated projections due to financial instability.
A Pause Was Discussed And Eventually Dismissed
In days prior to the Fed meeting, committee members considered pausing the rate hiking campaign due to uncertainty with some regional banks. The run on deposits at some banks in the U.S. created a bit of a scare. However, as the days passed, participants believed conditions were favorable for increasing rates and markets were stable enough for participants to publish updated Summary of Economic Projections (SEP).
Uncertainty in the banking sector created some division among committee members; however, the median rate forecast for 2023 was unchanged from December at 5.1%. The path for the rest of the year is muddied. Some forecast no more rate hikes, while others forecast quite a bit more tightening.
As risks of contagion seem to diminish, investors should expect the FOMC to focus on the inflation portion of the dual Congressional mandate for price stability and full employment, i.e., the growth component of the mandate. Unlike the Great Financial Crisis, larger banks are currently well-capitalized and hedged against broader economic risks, giving the Fed room to hike rates amid the volatility.
Tighter Financial Conditions Are Equivalent To A Hike In Rates
The Fed may not have to raise rates as much as they expect if financial conditions tighten, since tighter conditions translate into equivalent rate hikes. Given the recent deceleration of prices across much of the economy, the Fed can rightly soften their language about future rate increases. As of now, we anticipate that the Fed may hike rates another 0.25% during the May meeting.
The Markets And The Fed
The markets are at odds with the Fed. The FOMC does not plan on cutting rates this year, however the markets seem convinced the committee will indeed cut rates. Who is right? The markets are probably right because the impact of tighter financial conditions, softening consumer demand and a slowing economy will release some of the inflationary pressure.
Inflation fighting is still the Fed’s main focus. Both markets and the FOMC can agree on at least one thing—the outlook for inflation the rest of the year looks promising.
Impact From SVB
It seems that the Silicon Valley Bank failure is contained and the general financial system appears stable. Financial stability is clearly a vital factor in future Fed decisions. Although we see the the economy slowing down, conditions look like our baseline forecast this year will come to fruition. That is, the Fed pauses by the summertime and the economy ekes out slightly positive growth for 2023. In the near term, markets should respond favorably to the updated outlook and the latest decision.
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