US Fed hikes by 25bps, softens its stance
Amidst the banking crisis unfolding in the US and Europe, the Fed FOMC hiked the target range of Fed funds rate by 25bps to 4.75%-5%. This was in line with our, and broad market expectations, given the Fed’s focus on inflation and labor markets. The Fed in its statement pointed out strengths in the economy – job gains, low unemployment and high inflation. While the Fed acknowledged that recent developments in banking have led to tighter credit conditions, it reiterated its focus on inflation.
The Fed also revised its projections. Median projections suggest the Federal Funds rate peaking at 5.1% in 2023 before falling to 4.3% in 2024. Projections for GDP growth stood at 0.4% for 2023 and 1.2% for 2024, lower than December 2022 projections. Inflation projections (Core PCE) at 3.6% for 2023 and 2.6% for 2024 are higher than December 2022 projections. PCE Inflation projections for 2023 and 2024 remain way above the long-term projections.
In its Semiannual Monetary Policy Report to the Congress on 7th March 2023, Fed Chair Powell mentioned that inflationary pressures are running higher than expected. Powell also mentioned that “historical record cautions strongly against prematurely loosening policy. We will stay the course until the job is done.” Additionally, he stressed on continued significant reduction of the Fed’s balance sheet. However, after the collapse of SVB on 10th March and subsequent stress in the US banking system, the market had started to expect a softening in Fed’s hawkish stance. Some analysts were even eying a rate cut in this policy meeting. The market is also equating tight liquidity conditions and rising spreads due to the to the banking crisis to an effective rate hike of 50-150 bps. Fed’s balance sheet has swelled by $297 billion for the week ending 16th March 2023, reversing the trend of last year.
From yesterday’s statement, it seems that the Fed has softened its stance. Fed Chair Powell also mentioned that FOMC members did feel that the tight credit conditions as a result of the recent banking stress had effectively delivered a rate hike, though the exact extent can not be determined with certainty. A tighter monetary policy doesn’t have to come from higher rates alone. This is what led the Fed to deliver a rate hike lower than what was warranted basis their assessment of the US economy at the beginning of March 2023. We are of the view that Fed will hike by 25bps rates in its May 2023 policy and then hold steady. The Fed will likely wait for the current banking crisis to fully unfold and assess its impact. The Fed will also wait for more economic data to guide its future actions. However, there is some possibility of rates being steady in May, if the current banking crisis intensifies. Following Fed’s footsteps, we expect the RBI to hike the repo rate by 25bps in its next policy in April.
Source: FRED, TruBoard
Market reaction
Inflation and labor market beating Fed’s target
Spreads spiked in March 2023
Fed swells its balance sheet to support the banking crisis
Financial conditions not as tight as 2008 GFC or COVID
Inflation and labor market beating Fed’s target
Spreads spiked in March 2023
Fed swells its balance sheet to support the banking crisis
Financial conditions not as tight as 2008 GFC or COVID
Source: FRED, TruBoard
Market Reactions
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