The word “recession” came up three times in the March FOMC minutes, all in the staff economic outlook section.
“Given their assessment of the potential economic effects of the recent banking-sector developments, the staff’s projection at the time of the March meeting included a mild recession starting later this year,” the account of last month’s gathering, released on Wednesday, said.
In a scenario where the banking stress didn’t abate quickly and then deteriorated “more than assumed,” staff suggested a deep downturn was at least possible, “because historical recessions related to financial market problems tend to be more severe and persistent than average recessions.”
On the bright side, such a scenario would “skew the risks around… inflation to the downside,” staff said. (That’s dark humor. The quote is real, but Fed staff didn’t suggest that financial crisis-driven disinflation was a desirable outcome.)
Context is important. The March FOMC meeting played out in the shadow of the UBS-Credit Suisse shotgun marriage. In other words: A SIFI had effectively failed. The sense of angst was palpable.
During his post-meeting press conference, Jerome Powell did indicate that the Committee considered a pause last month, and Nick Timiraos, the Wall Street Journal‘s “Fed whisperer,” subsequently described the decision to proceed with another 25bps hike as an eleventh hour call. Consistent with that, the minutes said “several participants” considered whether it would be appropriate to pause in order to buy the Committee “more time to assess the financial and economic effects of banking-sector developments” and also the cumulative impact of legacy tightening.
Ultimately, though, the dovish contingent was brought around, comforted by the purported effectiveness of intervention on the part of Treasury, the FDIC and the Fed itself. “These participants also observed that the actions taken by the Federal Reserve in coordination with other government agencies helped calm conditions in the banking sector and lessen the near-term risks to economic activity and inflation,” the minutes said, of the officials who might’ve favored a pause.
The minutes went out of their way to explain why those who considered holding rates steady were eventually convinced of the utility in going ahead with another hike. In addition to the emergency measures undertaken by the government, those officials were cognizant of still-high inflation, robust incoming data and “their commitment to bring inflation down” to target.
On the other side of the hawk-dove spectrum, those who were leaning in the direction of supporting a step back up to a 50bps rate-hike cadence were convinced otherwise by the financial tumult. “Due to the potential for banking-sector developments to tighten financial conditions and to weigh on economic activity and inflation,” the hawks “judged it prudent” to opt for a smaller increment.
There were references to the idiosyncratic nature of the financial stress, and allusions to mismanagement at a “small number of banks.” There was no mention of the word “oversight,” and the only time “supervisory” came up was when Michael Barr was asked, by Powell, to “provide an update” on recent events.
Overall, the banking system was still “sound and resilient,” the Fed judged, and there was broad-based support for leveraging (figuratively and literally) the central bank’s “liquidity and lender-of-last-resort tools” to douse the flames.
As a reminder, the key words around the updated forward guidance are “some” and “may” — as in, because inflation is too high, and because the jobs market is still tight, “some additional policy firming may be appropriate” (emphasis mine).
“Many” officials lowered their projections for the appropriate funds rate to account for the “likely effects of recent banking-sector developments on economic activity and inflation.” In other words, SVB’s failure changed the definition of “sufficiently restrictive” for a likely majority of officials.
“Banking-sector” came up nearly a dozen times in the minutes. That tells you pretty much everything you need to know.
Oh, and everyone favored continuing to run down the balance sheet according to plan.
They Fed is now expecting a recession, their own GDP projections for the remainder of 2023 require negative growth in H2 and now their own research staff is stating the obvious about the effects of the banking mini crisis. Hiking one more time in May increases the odds they’ll have to cut this year, wouldn’t that be worst for Fed credibility? The Fed should show some confidence on the impact of their actions so far, another hike would likely do more damage than good at this stage.
The Fed’s base case is a mild recession this year, with the possibility of a severe recession, and yet the FOMC raised rates last month.
We should disabuse ourselves of the notion that “the Fed won’t do X to fight inflation because it will cause a recession” because it is wrong.
The alternative “the Fed shouldn’t do X because it will cause a recession” is not useful.
The remaining possibility that has the chance of being both right and useful, is “the Fed won’t do X to fight inflation because it will cause a severe recession”.
I think best to turn attention to the severity of the coming recession, not how the Fed can avoid any recession.
Question: Post-SVB, hasn’t every bank with an interest-rate mismatch by now hedged their exposure to elevated rates? Hope so. My prediction: FOMC will hike .25bps in May and then pause, with language to the effect that if disinflationary trends start to reverse, they’ll be back in the hiking game. I’d like to see the Fed adopt a “loose” Taylor rule, with rates ~200bps above core until the latter is below 3% and headed lower.
I briefly looked into bank hedging.
The impression I got is that if you hedge HFM, the unrealized G/L on the hedge flows to earnings while the unrealized G/L on the HFM does not.
Also the cost of the hedge may eliminate the meager income on the HFM, further impacting earnings.
I’m not at all sure of that, but there must be a reason why banks don’t routinely hedge HFM.