On Wednesday, the Federal Reserve raised interest rates by a quarter percentage point in an effort to combat persistently high inflation while addressing financial stability risks.
Despite the recent banking sector meltdown, investors and economists widely expected a quarter-point increase.
Nonetheless, Federal Reserve Chair Jerome Powell and policymakers entered their second policymaking meeting of the year facing an unusual level of uncertainty as the financial system’s landscape continues to shift.
So, what did the policy decision, economic projections, and Powell’s press conference on Wednesday teach us?
1. There will be no “pivot” this year.
Investors currently expect the Fed to lower interest rates before the end of the year, with rates ending 2023 somewhere between a half point and three-quarters of a point lower than where they are now (a range of 4.75% to 5%). However, investors are mistaken, according to Powell, who spoke at a press conference on Wednesday.
Powell stated that the central bank expects growth to slow and inflation to fall gradually this year and next. “If that happens, participants are unlikely to see rate cuts this year,” he said.
While the Fed is data dependent and future interest rate changes are “uncertain,” a rate cut this year is not in the central bank’s “baseline expectation,” he said.
2. However, perhaps a pause is in order.
In their statement on Wednesday, policymakers dropped previous language that predicted “ongoing increases” in interest rates, instead writing that the committee “anticipates that some additional policy firming may be appropriate.”
This is an example of classic Fed speak, in which minor changes in language convey a great deal of implied meaning. During his press conference, Powell urged investors to focus less on “policy firming” and more on “some” and “may.”
So, what does this imply?
Prior to the banking crisis, the Fed was fairly certain that more rate hikes were on the way. They can now press the pause button.
Still, pausing rate hikes is not the same as completely stopping them.
“The process of returning to 2% inflation has a long way to go and is likely to be bumpy,” he said.
In deciding how to proceed with policy, the Fed will consider data as well as the impact of its rate hikes, he said. “Inflation has moderated somewhat since the middle of last year,” Powell said, “but the strength of these recent readings indicates that inflation pressures remain high.”
3. More banking regulations are required.
While Powell repeatedly stated that the US banking system was sound and resilient, he did admit that Silicon Valley Bank’s management “failed badly,” exposing its customers to “significant liquidity risk and interest rate risk.”
“My only concern is that we figure out what went wrong here,” he said, adding that stronger supervision and regulation are needed to prevent further bank failures and runs.
However, Powell stated that the Fed would not jump to conclusions, adding that it would be “inappropriate for me to offer my views on what the answers might be at this stage.”
4. However, the banking crisis may contribute to lower inflation.
Before the Bell on Wednesday focused on how the recent banking crisis may have done some of the Fed’s work for it. During his press conference, Powell appeared to agree with that assessment.
He predicted that the banking crisis would “likely result in tighter credit conditions for households and businesses, which would in turn affect economic outcomes.” Nonetheless, “it is too early to tell how monetary policy should respond.”
Fears of a bank run prompt lenders to take fewer risks with their capital reserves in order to ensure they have enough cash to cover any potential withdrawal requests. This means that banks may stop lending to certain borrowers, deny loans to certain businesses, and issue fewer mortgages. It also implies that the economy will cool, potentially leading to layoffs and a slowing of the housing market.
In its fight against inflation, the Fed has attempted to do just that: slow the economy.
On the other hand, the banking crisis may not have a negative impact on the economy. Powell stated that the Fed is keeping a close eye on the situation.
“It’s possible that these events will have only minor effects on the economy, in which case inflation will remain high and, you know, the path might look different,” Powell said.
“It’s also possible that this potential tightening will contribute significantly to credit tightening over time.” In theory, this means that monetary policy may have less to do. We just don’t know.”
5. Powell is willing to take the risk of job losses.
The Federal Reserve anticipates that unemployment will rise as it cools the economy in an effort to reduce inflation.
According to the Federal Reserve, the unemployment rate will rise to 4.5% by the end of the year, up from 3.6% last month. This could result in over a million more Americans being out of work by the end of 2023.
Powell described the outcome as uncertain but acceptable: “We have to bring inflation down to 2%,” he said in response to a question I posed on Wednesday about the risk of unemployment snowballing. “There are real costs to lowering it to 2%.” However, the costs of failure are much higher.”
“If the central bank does not restore inflation, there could be a long period of high and volatile inflation.” And it is difficult to invest capital. It is difficult for an economy to perform well. And that’s something we’re trying to avoid,” Powell said.
What else are investors looking at on Thursday?
While Powell was speaking, US Treasury Secretary Janet Yellen spooked markets on Wednesday by testifying at a Senate hearing on Financial Services and General Government.
According to Yellen, federal bank regulators have not discussed plans to insure all US bank deposits. Following the banking turmoil of the last two weeks, there have been calls for a larger deposit guarantee, and Powell stated on Wednesday that “all depositors’ savings are safe.””I have not considered or discussed any blanket insurance or guarantees of all deposits,” Yellen said.
Yellen described Silicon Valley Bank’s rapid demise as a “new phenomenon,” adding that the circumstances that led to its demise could occur again.
“The Silicon Valley Bank situation demonstrated an incredibly rapid run on a bank.” “We’ve never seen deposits flee at this rate before,” she explained. “In today’s world, even though this was a small community with a disproportionate share of Silicon Valley Bank deposits, this type of thing could happen more easily.”
The Dow fell more than 500 points, and the S&P 500 and Nasdaq Composite both fell more than 1.5%.
However, markets are volatile after Fed meetings, and traders’ perspectives on the meeting may change in early trading. Investors will also have a lot more to think about in the coming days.
The Fed raised interest rates on Wednesday, but more central bank announcements are on the way. ET. In the early evening, the Fed will also release its Balance Sheet update, which investors will closely monitor to see if more banks are taking out emergency loans.
Hold on to your hats, there’s a lot more to come.