Despite new threats from some instability in the banking industry, the Federal Reserve hiked the fed funds rate by 25 basis points in March, while still focusing on combating inflation.
After a wild couple of weeks of gyrating expectations (and lots of will-they-or-won’t-they debates) around Federal Reserve policy, the Federal Open Market Committee (FOMC) announced today a 25 basis points hike in the fed funds rate, to a range of 4.75% to 5%. It was the second consecutive increase of that size, following a series of larger hikes. Heading into the decision, the market was pricing in an 83% chance of 25 basis points, and a 17% chance of a pause. The decision was (somewhat surprisingly) unanimous.
Importantly, the FOMC’s statement said that the “U.S. banking system is sound and resilient,” but also warned that “recent developments are likely to result in tighter credit conditions for households and businesses and to weigh on economic activity, hiring, and inflation,” further noting that the “extent of these effects is uncertain.” The statement was missing prior language about inflation having eased, instead noting that price pressures remain elevated alongside job gains that are “running at a robust pace.” The statement also had no reference to the Russia/Ukraine war, which was mentioned in the prior statement.
In the immediate aftermath of the failure of Silicon Valley Bank (SVB), the Fed and other regulatory bodies announced backstops, including a new emergency lending facility to banks, as well as an increase in the frequency of U.S. dollar swap lines with foreign central banks (the latter of which the Fed announced last Sunday). Since then, concerns about liquidity led to banks having borrowed a record amount (during a single week) from the Fed’s backstop facilities and its discount window; exceeding the prior high during the global financial crisis in 2008. For more details on SVB and the policy response to date, check out our “Another One Bites the Dust” report from earlier this week.
In terms of the near future, the FOMC’s statement noted that the Fed “anticipates that some additional policy firming may be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2% over time.” Relative to what I bolded in that statement, it’s interesting that the prior statement said that “ongoing increases” in rates would be appropriate. Perhaps the nuance of the semantics around that change suggest the Fed wants to send a message of flexibility with regard to when to pause/stop rate hikes.
The dots plot is shown below, with the key message that the FOMC is now projecting rates will end 2023 at about 5.1%, unchanged from the median estimate from the last round of projections in December of 2022 (and implying one additional hike from here). Notably, there were seven dots above the median, with one as high as 5.9%, while the median 2024 projection rose from 4.1% to 4.3%. The decision today, as well as the message imbedded in the forecasts, suggests the Fed views still-high inflation as a more significant threat than the current turmoil in the banking system.
Source: Bloomberg, as of 3/22/2023.
The risk, of course, is that the economic growth threat is being underestimated; and the need to continue to combat (the lagging indicator that is) inflation is being overestimated. At the same time the Fed has opted to remain on its tightening path, it’s highly likely that many banks—particularly small/regional banks—further tighten lending standards, contributing to elevated recession risk.
Below is the FOMC’s summary of economic projections (SEP) with median forecasts and comparisons to the December 2022 projections. We would not put a lot of analysis attention on the forecasts for 2024 or 2025. For this year, forecasts for gross domestic product (GDP) edged lower, but so did the forecast for the unemployment rate; while inflation projections moved up.
Source: Charles Schwab, Federal Reserve, as of 3/22/2023. Note: Projections of change in real gross domestic product (GDP) and projections for both measures of inflation are percent changes from the fourth quarter of the previous year to the fourth quarter of the year indicated. PCE inflation and core PCE inflation are the percentage rates of change in, respectively, the price index for personal consumption expenditures (PCE) and the price index for PCE excluding food and energy. Projections for the unemployment rate are for the average civilian unemployment rate in the fourth quarter of the year indicated. Each participant’s projections are based on his or her assessment of appropriate monetary policy. Longer-run projections represent each participant’s assessment of the rate to which each variable would be expected to converge under appropriate monetary policy and in the absence of further shocks to the economy. The projections for the federal funds rate are the value of the midpoint of the projected appropriate target range for the federal funds rate or the projected appropriate target level for the federal funds rate at the end of the specified calendar year or over the longer run. 1For each period, the median is the middle projection when the projections are arranged from lowest to highest. When the number of projections is even, the median is the average of the two middle projections. 2Longer-run projections for core PCE inflation are not collected.
As is typically the case, the summary of highlights from Fed Chair Jerome Powell’s press conference will include the first 45 minutes or so, in the interest of getting the report into the publishing queue.
The Fed has a fairly small opening in the needle it’s trying to thread in balancing the threats associated with the banking crisis and the need to combat still-high inflation. Powell made it a point to say there are costs to bringing inflation down to the Fed’s 2% target, but the costs associate with allowing inflation to remain high are more severe. We believe the environment is likely transitioning from what has been more of an “asset crunch” to a more traditional “credit crunch,” which will slow economic growth (but also help bring down inflation). Although Powell said there remains a “pathway” to a soft landing; we believe what we’ve been calling a “rolling recession” is more likely to roll into a more formal recession.
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