Key takeaways from March FOMC rate decision

The FOMC raised the target range for the federal funds rate as expected by 25bps to 4.75-5% and indicated there may be one more hike to come.¹

Despite the recent banking sector stress, the Fed has signaled that its battle against persistent levels of elevated inflation must go on.

Still, if it wasn’t for the recent banking emergencies, the Fed would have likely outlined another two to three more 25bps hikes for the rest of the year – instead of one.

Even after today’s FOMC decision and statement, I don’t believe markets are accurately pricing in a 2023 terminal rate, with cuts estimated to start in the 2H.

The Fed has made its intentions known – it will fight inflation with policy rates and banking sector problems with other targeted financial tools.

Furthermore, the Committee reiterated that it “remains highly attentive to inflation risks.”

Despite the US market sell-off yesterday as hopes for a rate cut dissipated, I actually believe that this FOMC meeting has been a little more dovish than what meets the eye.

For example, the Fed’s median dot plot in the summary of economic projections has been left unchanged. It projects the benchmark rate to be 5.125% at the end of 2023, which suggests only one more rate hike of 25bps for the rest of the year.

Additionally, the Fed’s statement on future rate hikes has been “dovishly” adjusted to “some additional policy firming may be appropriate” rather than “ongoing increases in the target range will be appropriate.”

Powell reiterated during his press conference that rate hikes continue to be the primary policy tool and not alternatives such as balance sheet runoffs.

Recent financial instability

While the recent banking sector woes have tightened credit conditions, it’s still unclear how long this will last for.

The post-meeting statement noted that, while the “banking system is sound and resilient,” the recent banking stress is likely to “weigh on economic activity, hiring, and inflation." 

During the press conference, Chair Jerome Powell emphasized his belief that the banking system remains resilient.

Still, Powell noted that tightening credit expectations and the recent financial instabilities have been taken into consideration by FOMC members, and that the policy rate forecasts would have moved higher by at least one or two more 25bps hikes.

Summary

The macro backdrop has become more complicated with the recent financial sector challenges. I expect a bit of a negative drag on the overall growth of the US economy due to tightened financial conditions.

The silver lining is that these tighter conditions could do the work for the Fed and counteract high levels of inflation.

Thus, the FOMC’s more dovish rate hike this month makes sense, because on the one hand, core inflation remains strong and is expected to persist in the coming months, while on the other hand, the recent banking emergencies could weigh down on growth and inflation.

Looking ahead, the Fed is likely to keep a very close eye on the monthly inflation and labor market data as well as business sentiment indicators and banking sector data.