The Federal Reserve raised interest rates by 25 basis points, signalling a peak of the Fed funds target range
No real surprises: The Federal Open Market Committee voted unanimously to raise rates by 25 basis points, bringing the Fed Funds target range to 5-5.25%.
We cannot say that the Federal Reserve has completely abandoned its tendency to raise rates, but the statement is more balanced than in March.
At that time, it said that „additional tightening of monetary policy may be appropriate„. That has been deleted, and it now says only, „In determining the extent to which additional tightening of monetary policy might be appropriate to bring inflation back to 2 percent over time, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments„.
The press conference mentions a possible pause at a future meeting, but Powell also indicates that the Committee is „prepared to do more” rate hikes if necessary.
Nonetheless, he acknowledges that „policy is tight” and that ” real interest rates are well above what many people would consider a neutral rate„.
In any case, the change in language by omitting the phrase „additional policy tightening may be appropriate” is important and signals that the bar for justifying future rate increases is now higher.
Rather surprisingly, Fed Chairman Powell stated in the press conference that conditions in the banking sector had „largely improved” since the collapse of Silicon Valley Bank and Signature Bank in March.
This seems a bit odd, given what has happened to First Republic in recent days. Nonetheless, the statement acknowledges that „tighter credit conditions for households and businesses are likely to weigh on economic activity, hiring, and inflation.” The last point about inflation is crucial.
Indeed, the Fed will have seen the latest Senior Loan Officers Survey, and it may not have been pretty, judging from yesterday’s ECB Bank Survey (the Fed’s survey will likely be officially released next week).
The recent tensions in the banking sector will lead to a significant tightening of lending standards, which will significantly slow economic activity and significantly reduce the need for further rate hikes.
Tighter lending standards increase risk of recession
Chairman Powell spoke of numerous risks to the outlook, and is believed today’s rate hike marks the peak of the Fed funds target range. The Fed will leave rates unchanged at the June 14 FOMC meeting as recessionary forces strengthen, layoff announcements increase, and inflation slows.
This will coincide with new projections from Fed officials, including an update to their dot plot chart for the likely path of the fed funds rate.
At this point, we expect no changes between now and the end of the year, with the Fed possibly planning 75-100 basis points of cuts for next year.
Powell reaffirmed that his personal forecast calls for modest growth and no recession, although Fed staff forecasts still call for a „mild recession.”
Historically, the Fed does not take long to cut rates – over the last 50 years, the average time between the last rate hike and the first rate cut has been just six months.
This means that if May is indeed the last rate hike in a typical cycle, we should expect a rate cut around November.
However, the March FOMC minutes warned that „historical recessions related to financial market problems tend to be more severe and persistent than average recessions.”
Given the tensions in the banking sector and rapidly tightening lending conditions, we fear that this could be the trigger for a painful economic downturn.
We know that unemployment rises whenever banks tighten their lending conditions. What makes a struggling business a failing business is that the bank pulls the plug when the business is out of options. Job losses are the inevitable result.
Interest rate cuts possible in fourth quarter of 2023
Fears that the U.S. debt ceiling cannot be met and that financial markets and the system could suffer before policymakers reach an agreement to prevent a default add to the sense that clouds are darkening over the economic outlook, which may require a rapid change in the Federal Reserve’s stance.
The market is currently pricing in the potential for rate cuts as early as September, but it is not sure the Fed will respond that quickly, given that inflation is still expected to be at 4% at that point, double the 2% target.
Still, the Federal Reserve has a dual mandate to both maximise employment and achieve a 2% inflation rate over time.
Article based on a story from ING Bank as copyright owner