The Federal Reserve Open Market Committee (FOMC) lifted the federal funds rate by a quarter point to the 4.75% to 5.0% range and announced a continuation of its balance sheet runoff.
The Fed adjusted to acknowledge the current banking stress stating, “the U.S. banking system is sound and resilient. Recent developments are likely to result in tighter credit conditions for households and businesses and to weigh on economic activity, hiring, and inflation. The extent of these effects is uncertain. The Committee remains highly attentive to inflation risks.”.
It also shifted its language on the future path of policy in a more dovish direction, adding that “the Committee will closely monitor incoming information and assess the implications for monetary policy.” Also shifting from “ongoing increases in the target range” in January, to “The Committee anticipates that some additional policy firming may be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive”.
The Fed’s Summary of Economic Projections was updated from December, downgrading growth over the near term, but upgrading inflation as follows:
- The median projection for real GDP growth for 2023, 2024, 2025, and the longer run came in at 0.4%, 1.2%, 1.9% and 1.8% (from 0.5%, 1.6%, 1.8%, and 1.8%), respectively.
- The median unemployment rate forecast for 2023, 2024, 2025, and the longer run came in at 4.5%, 4.6%, 4.6% and 4.0% (from 4.6%, 4.6%, 4.5%, and 4.0%), respectively.
- On inflation, the median estimate for core PCE was assumed to be 3.6% in 2023, 2.6% in 2024, and 2.1% in 2025.
- The median projection for the fed funds rate was 5.1% in 2023, 4.3% in 2024, and 3.1% in 2025. The long-run neutral rate was assumed to be 2.5%.
All of the members of the FOMC voted in favor of the decision
Key Implications
This was one of the most contentious decisions the Fed has had to make. When inflation was its singular focus over the last year, raising rates was the only option. But now that the stability of the financial system has been brought to the forefront, the Fed is having to toe a fine line. By raising rates, while focusing the statement on the tail risks, it is acknowledging the flow through of financial market stress on the broader economy. The changes in the Fed’s economic projections were for weaker growth over the next two years and higher inflation. In contrast to what was signaled a short time ago, the median “dot” for the end of this year was unchanged, suggesting that the downdraft from tighter credit conditions is expected to weigh on economic momentum enough to negate the need for the further rate hikes discussed only two short weeks ago.
Chair Powell is ready to speak, and we expect a flurry of questions, with investors eager to know how the Fed expects to manage its policy rate with so many crosscurrents challenging the outlook. Even though the Fed’s projections point to another forthcoming rate hike, markets are getting ready for cuts to start by this summer. That would be an incredibly quick turnaround should the Fed hike again in May. This aggressive pricing has bond yields falling again. Let’s see if Powell tries to lean against markets once more.
