“The US banking system is sound and resilient,” the Fed insisted Wednesday, while pulling the trigger on another 25bps rate hike.
Headed into the decision, many observers argued the Committee should consider a pause in light of what it’s fair to describe as the most tumultuous two weeks for the US banking system since the financial crisis.
In addition to the cognitive dissonance inherent in a Fed that insists on raising rates and shrinking its balance sheet at a time when discount window usage and FHLB issuance to fund banks’ liquidity needs are at historic levels, lenders are sure to pull back given rampant uncertainty, which could have the same effect as additional rate hikes.
The Fed acknowledged that latter point in the new statement. “Recent developments are likely to result in tighter credit conditions for households and businesses and to weigh on economic activity, hiring and inflation,” officials said. The median dot for 2023 was unchanged, indicative of what I’ll euphemistically call the new distribution of risks.
The forward guidance was softened. In February, the Fed expected “ongoing” rate hikes would be necessary to achieve a sufficiently restrictive policy stance. Now, the Committee believes only that “some additional policy firming may be appropriate.” That’s perhaps more dovish than meets the eye. Policy “firming” is less specific, for one thing, but more importantly, “some” and “may” are indeterminate. This could be the last hike.
The median dot for 2024 shifted higher, and both the 2025 dot and the longer-run estimate were unchanged. There were no changes to the balance sheet plan.
The most notable SEP tweak was a fairly substantial downgrade to the 2024 growth outlook. The Fed now sees a 1.2% expansion next year compared to 1.6% in December. This year’s outlook was revised slightly lower.
The PCE projections for 2023 were nudged up to 3.3% (from 3.1%) and 3.6% (from 3.5%) for headline and core, respectively. The 2024 core projection got a token bump (to 2.6% from 2.5%) and both headline and core projections for 2025 were unchanged at 2.1%.
Job gains were described the only way they could be: They’ve “picked up” and continue to run “at a robust pace,” said the statement. The unemployment projections were basically unchanged. 2023 was 4.5% versus 4.6% in December, and 2025 was nudged up to 4.6% from 4.5%. All of those levels are plainly higher than where the jobless rate sits today.
Ultimately, the Fed tried to thread the needle. In addition to being a nod in the direction of too-high inflation, the 25bps hike was probably supposed to instill confidence in the banking system. Pausing might’ve suggested to traders that the Fed knew something they didn’t, or so said those who argued for the hike the Fed delivered.
The forward guidance is now as dovish as it’s been this cycle, and the dot plot reflects a Committee that recognizes they might’ve broken something.
All references to Russia and Ukraine were dropped from the statement.
Welcome to stagflation. I’ll believe 2-3% inflation the day after the 32nd of March….
I’m looking forward to your commentary on UST rallying on the news and Powell’s comments.. My favorite question of the day was regarding markets pricing in cuts by the end of the year despite any material indication from the voting members..
What I’m taking away from today.
The Fed understands, more granularly than anyone, how the US banking system works, the current state of bank balance sheets, and the pressures on banks to pull back lending. It knows what the deposit outflow has been at each bank and who has borrowed how much, each day. The Fed also has a sense of what regulatory controls it may impose on banks. The FOMC members are in close contact with the banks in their districts, and surely more so now. This is the part of the economy that the Fed runs, and thus knows best.
So the FOMC probably has a fairly good sense of how much bank credit will slow – not exactly, but a probable range – and how close banks really are to distress.
Sure, the Fed didn’t prevent the SIVB run, but it seems – and Powell’s Q&A suggests – that what surprised the Fed was not so much SIVB’s condition, which he said the examiners were aware of and issuing SIVB urgent warnings/directives about – as the lightning-fast, VC-driven, and social media-supercharged nature of the run. SIVB was shut down midday Friday, not the customary end of day Friday.
I think the 25 bp decision and “now we watch and see” tone suggests two things:
First, the Fed doesn’t see other banks (of any relevant size) that are about to fail in a messy, shocking way and spread contagion. E.g. maybe FRC will or won’t remain an independent entity, but the Fed believes it (and FDIC, and maybe JPM) can keep things orderly. If FRC or another regional was imploding as we speak, I don’t think the Fed would have done even 25 bp.
Second, the Fed believes the probable credit inpact is significant. At least equivalent to a 25 bp hike, and likely to 50 bp. While the FOMC were previously leaning toward 50 bp – that’s what I took from the Q&A – they did 25 bp and changed their tone from “and there’s more to come” to “err, we’ll have to watch and see”. That’s at least 50 bp taken away right there, and not because there was good news on inflation in the past months – Powell emphasized that, from their perspective, the inflation data got worse not better.
If that’s right, this seems bullish for any regional trading at prices implying imminent failure, and bearish for that portion of the economy who are reliant on bank credit or the employment or spending of those who are.
This also seems incrementally favorable for larger companies and incrementally unfavorable for SMB companies, due to the different sources of financing used.