There was little utility in parsing the macroeconomic nuance ahead of this week’s FOMC meeting.
Less than two weeks ago, traders were on edge about the prospect of the Fed returning, however briefly, to a half-point hike cadence amid scorching-hot US economic data and concerns that services sector inflation wasn’t moderating consistent with efforts to restore price stability. Seven trading sessions and one banking sector crisis later, the idea of a 50bps hike at the March meeting was laughable.
The decision is between i) a 25bps move aimed at underscoring the Committee’s commitment to the inflation fight paired with a statement that acknowledges recent events and an SEP that somehow reflects the new distribution of risks, and ii) a pause paired with a statement that acknowledges the distinct possibility of hikes resuming and an SEP that reflects that possibility.
What the Committee can’t do (or shouldn’t do) is pair a 25bps hike with an obtuse statement and a new dot plot that looks anything like it would’ve looked had the March FOMC meeting concluded the day before SVB collapsed. As TD’s Priya Misra put it+, such an outcome “will likely be viewed by the market as being very hawkish and even out of touch,” assuming no improvement in sentiment around the banking sector. (Ironically, a 25bps hike and a dot plot suggesting more hikes remained TD’s base case as of late last week.)
Terminal rate pricing plummeted by some 90bps from the highs seen just prior to the onset of the crisis, to levels well below the median 2023 dot from the December SEP. “The market is pricing in only 70% chance of a 25bps hike in March and 40% in May,” TD’s analysts wrote, in an FOMC preview called, appropriately, “Hell and High Water.”
“The market is pricing in the first 25bps cut in July 2023 and a total of 170bps of cuts by the end of 2024,” TD added, for context, before noting that in their view, the Fed will get a “slightly later” start on cuts, but will ultimately ease more than markets are pricing.
“The Fed’s projected path will be telling insofar as the terminal estimate remains likely to be increased. The recent developments significantly reduce the prospects for a 6-handle on terminal [but] a 5.4% median dot projection remains well within the realm of conceivable outcomes and is our best estimate,” BMO’s Ian Lyngen and Ben Jeffery said, adding that, “In keeping with the theme of instilling confidence in the banking system, Jerome Powell will reiterate that further progress needs to be made toward the goal of price stability — even if this endeavor might soon run up against mounting evidence of the impact of the cumulative tightening already in the system.”
Powell will have to reiterate the Fed’s commitment to providing liquidity to the banking sector, and if the Fed is intent on forging ahead with hikes, the messaging around regional bank stress will center on the idea that the discount window is open, and the new bank term funding facility is too. To some observers, though, heavy usage of the Fed’s liquidity facilities, should it continue, would appear incongruous with QT. The same could probably be said of FHLB advances. Powell will need to reconcile that, and given his track record when it comes to communicating nuance, I doubt he’ll pass the test.
Do note: QE, “backdoor” or otherwise, with rate hikes is a scenario that more than a few strategists saw as inevitable. R-star is probably higher than r-double-star, and that means the Fed needs to persist in a policy bent that’s conducive to below-trend growth in the real economy while simultaneously preserving financial stability through liquidity facilities.
Although I realize the vast majority of readers understand this, some invariably don’t, so let me reiterate: The blue line in the chart doesn’t show the resumption of Fed bond-buying. It reflects discount window borrowing, the FDIC’s bridge banks and a relatively small take-up at the newly-created bank term lending facility (usage of that facility will probably balloon going forward). The effect on reserves might be characterized as “reversing” QT, but it’s not QE, or at least not on a strict definition.
It’s important that market participants come to terms with the following somewhat awkward reality. Not only will you be expected to countenance the juxtaposition between i) policy rates that appear “high” by the low standards of the last two decades, and ii) ongoing liquidity provision on a potentially large scale depending on the circumstances, you’ll be expected to accept it as part of the plan.
Plainly, all of this presents Powell with a monumental communications challenge this week. The other concern the Committee is grappling with relates to the (very real) possibility that not following through on one more 25bps hike would signal something about policymaker angst regarding the banking sector, at cross purposes with various efforts to communicate confidence last week (via Powell’s joint statements with the Treasury and FDIC).
During last month’s hawkish US rates repricing, the market was briefly disabused of the notion that cuts were possible in the back half of 2023, but the bank chaos rekindled speculation on a panic pivot.
Late last week, in “Signs Of The Financial Apocalypse”+, I suggested Wall Street’s attempted rescue of First Republic might’ve marked a turning point in this (still very young) crisis. However, in the very next breath (i.e., in the very next sentence), I cautioned that,
If the storm worsens and the turmoil starts to manifest in broader funding stress, wider bases, more counterparty worries between large financial institutions and even worse liquidity in Treasurys, monetary policy would have to respond accordingly, lest Main Street should have a bigger problem than inflation.
That warning stands as the new week dawns.
I never have understood the Fed’s obsession with shrinking their balance sheet. The time has certainly come to end QT. A bank run is on, so draining liquidity makes little sense. For those that say, if the FOMC stops raising rates, that will spook the market since it will be indicative that the Fed is panicking. Duh, there is a bank run, the panic is already out there. There is nothing wrong with the central bank saying in light of the changed circumstances, we will at least take a temporary pause in raising rates. If inflation stays sticky and the situation calms down more, and warrants rate increases we are very open to doing that as soon as the next meeting. As for the argument that the lender of last resort function is separate from broader monetary policy- that is a straw man. It is all monetary and financial stability policy- whether it is the Fed’s balance sheet, bank regulation, short term policy rates or any other policy. It all goes into both financial stability and regulating the economy. Separating the functions is just not how the real world works. You can live in your ivory tower and think otherwise if you so choose but that is just not how things work. If you are a practicing economist, if your model does not bear some semblance to how our market economy functions then you have to change your model or start from scratch.
And if the government is constantly backstopping the banks shouldn’t the government just own them?
Instead of being the “lender of last resort”, just be “the lender.”
Excellent point. Most Smaller banks can’t afford to pay depositors a yield that is competitive with short term US Treasury bonds or money market funds. I’d be curious to know what percentage of depositors in small and medium banks have money in a checking/savings account or CDs in excess of $250,000 FDIC insured limit. What if FDIC raised insured limit to $500,000, or $1million AND increased fractional reserve capital requirement instead of backstopping everything. I bet confidence in banking system would get stronger if nearly half of small banks would be bought by only the stronger medium size institutions. We should avoid backstop/bailout of all banks forever because that smells too much like “nationalizing” the banks. And I totally agree that promising something for a year or two will invariably morph into a commitment for perpetuity.
Then the government would be in the business of allocating credit. Not a good idea.
See Fannie Mae.
So El-Erian is on bloomberg urging a 25 at this meeting. What a shock. Not a good idea in the middle of a bank run. Will be interesting to see the market reaction to forced Swiss Bank merger tonight. Trouble still lurking in the USA for non sifi banks.
As disingenuous and self-serving as Ackman can be, he makes a valid point about not wanting stronger banks incurring any risk by using their precious capital deposited in weak or poorly managed banks to create the appearance of confidence. It’s not fooling anybody as shown by First Republic Shares dropping double digits on Friday despite the announcement of the capital infusion. Depositors in strong banks aren’t thrilled about even a nickel of their deposits allocated to a bank that Moody’s and Fitch have downgraded to junk status if I’m not mistaken.
The risk in FDIC backstopping all deposits is that people start wondering how that’s even realistically possible. So going down that road is best avoided by maintaining rock-solid iron-clad confidence in FDIC by not imposing unrealistic mandates on them.
There needs to be tighter regulation of non “sifi” banks. Raising insurance limits for deposits is an ok idea if premiums are set by profit making firms for a tranche with fdic picking up the tail and the banks paying for insurance on a bank by bank basis. Rates could vary by bank depending on the bank’s risk.
And so it continues, socialism for the rich, blame for the poor. Where’s all the blame for banks that ignored the Fed’s transparency and invested as if QE was coming back last year? On the Fed? And remember when inflation was all the working class’s fault for having too much money and buying things they want and need? It definitely wasn’t the Fed’s fault for keeping QE going too long nor the banks fault for providing too much credit liquidity. It was the people spending the money that were the problem! Borrowing 6X what you are capable of earning to purchase an overpriced house? Love it! How about a 10 year auto loan on an overpriced truck that will cost you even more when oil spikes, let’s do it!
When I make bad investments, no one blames the government for why I made them. But when the banking industry (who always wins) screws up, well, we need to protect them and deregulate them and make sure that they keep making money no matter what happens without consequences forever.
We seriously need to wake up here. Do we want intrenched hyper inflation? Do we really want to keep relying on a banking sector that only still exists because the Federal government protects them? Why in the world is Wells Fargo even still a company? Because the banks always win even when they continuously screw over their customers ever single year for the past two decades. Rant = over.