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March 24, 2023
This past Wednesday, the FOMC announced yet another 25 basis point hike in the Fed policy rate. This marks the second quarter point hike in a row which has been a stepdown from the prior 50 basis point hike. While the past few meetings have come off as convincingly hawkish, this seemed to be the first meeting that was equal parts hawkish and dovish since the rate hike cycle began.
The meeting began quite dovish which initiated a surge in the S&P 500. As the Fed does once per quarter, they released their revised economic projections. The terminal policy rate for this year was left unchanged at 5.1%, while the terminal rate for 2024 remained below this years’ projection, thus reaffirming the Fed, at a minimum, expects to cut rates next year. Powell also opened by acknowledging the issues that have occurred at a small number of banks over the past few days. He went on to explain that the credit tightening these issues will drive should permit the Fed to be less aggressive with their policy rate tool, once again hinting that this hiking cycle is nearly over. Finally, Powell confirmed that a pause in rate hikes was considered in the days leading up to the meeting. While his comments were unsurprising, the market hangs on every word Powell speaks during his press conference, so the very fact that he verbally acknowledged there was a possibility of a pause proved a welcome consolation prize for the doves.
Since the beginning of the rate hike cycle, there has been language in the Fed statement that read, “The committee anticipates ongoing rate increases will be needed.” Many expected this sentence to be removed as the committee considers the implications of further rate hikes. Instead, it was replaced by a still somewhat hawkish, “Additional policy firming may be needed.” Powell further clarified that this change in language implies two things: 1) There is further uncertainty due to the banking issues that have occurred in the last few days, and 2) Investors should focus on the Fed policy projections and macroeconomic conditions to understand future rate paths.
Turning to the economic projections, the 2024 terminal rate, while still below this year’s projected rate, was raised 20 basis points to 4.3%, further supporting what seems to be the Fed’s new motto of “higher for longer.” Other economic projections also supported the need for a “higher for longer” policy rate. Projected terminal 2023 and 2024 core PCE, the Fed’s favorite inflation measure, was raised 10 basis points to 3.6% and 2.6%, respectively, while unemployment is now projected to end the year at a stubborn 4.5%, 10 basis points lower than previously expected. Both a higher inflation rate and a stubbornly low unemployment rate would clear the path for a “higher for longer” policy rate.
Powell finished the press conference quite hawkish as he once again emphasized that no one should doubt the Fed’s commitment to getting inflation back to their 2% target. He went on to explicitly state that rate cuts are not in the Fed’s base case for this year- something that can be surmised just by looking at their economic projections which are presumably the median base case.
As a firm who attempts to remain centrist (we refuse to call ourselves pigeons), we regarded this meeting to be pleasantly rational and unsurprising. Powell hinted at what the Fed was going to do in the past meeting and they followed through on it. At some point, it’s certainly possible there will be a disconnect between what Powell says the Fed will do and what they actually do during that next meeting. This premature pivot would require something relatively extraordinary to happen, possibly resulting in a less than soft landing. While the market momentarily believed the recent problems at several small banks would be that exogenous factor that forces a pivot, it could also be a dramatic drop off in inflation, employment, or earnings.
Depending on how you look at it, there were a number of changes in the economic projections that can read as hawkish or dovish. Real GDP projections, which exclude the effects of inflation, for both this year and next were lowered, signifying a cooling economy which could justify sooner rate cuts. It could also signify a sooner recession if the Fed does not act appropriately. The projected unemployment rate was also lowered for this year which, again, could be a good or bad sign depending on how you look at it. The glass half full: More people have jobs and it’s hard to slip into a recession when everyone has jobs. The glass half empty: More people have jobs which means more people have money. More people with more money means more demand-driven inflation, and thus, higher for longer rates.
Right as Powell began Q&A at the press conference, Treasury Secretary Yellen was telling members of a Senate Appropriations subcommittee that the federal bank regulators are not considering any plans to insure all U.S. bank deposits without congressional approval. There had been hope in the days leading up to the Fed rate hike that the government would announce they will insure all bank deposits beyond the FDIC covered $250,000. Yellen’s comment came at the same time Powell, in answering a question, said “You’ve seen that we have the tools to protect depositors (…) and the agency is prepared to use all of our tools.” These offsetting remarks sent the market to its intraday lows. Once again, the market hangs on the words of powerful people, when in reality, it’s difficult to imagine a scenario where the US government allows bank failures to affect underlying deposits. Your average US citizen does not look at insured percentage of deposits or the duration mismatch of a bank’s assets and liabilities before becoming a depositor. Nor should they have to.
To once again summarize in an aviatic metaphor, we see the lights on the runway, but two or three bulbs blew out. It’s a bit harder to see the landing, but it’s there. We must carefully watch what kind of 2nd and 3rd order effects the recent banking issues will induce, if any. We must carefully watch our favorite inflation and employment indicators. And perhaps most importantly, we must listen to what the pilot has to say. Powell has continuously hinted to us what the Fed is going to do, and he has continuously executed on his word.
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Sawyer is a Senior Associate in our Boston office where he serves as a research analyst conducting due diligence, security selection, and trading for firm's...
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