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Fed Sees Rates Close To Peak Levels, Downplays Banking Risks



The Federal Reserve raised rates 0.25%-percentage-points to 4.75% to 5% to fight inflation at its March meeting. However, the Fed believes it is increasingly close to the top of the interest-rate cycle for 2023 with a majority of policy makers seeing one more hike coming, and no Federal Reserve policy maker forecasting rates of over 6% according the Fed’s economic projections. However, the Fed does expect to hold rates at peak levels for some time. The market agrees that we are close to peak interest rate levels, but sees rate cuts sooner than the Fed itself projects.

The outcome of this meeting was especially uncertain given recent events. The Fed chose to maintain the relative focus on inflationary risks, implicitly suggesting some degree of confidence in the U.S. banking sector. The Fed stated that “the U.S. banking system is sound and resilient.” Overall, the Fed continues to argue that getting inflation down is a painful process, but the costs of failing to successfully manage inflation are materially greater. Based on recent data, it’s likely data on the housing costs may be instrumental for path of inflation over the coming months.

Events Since The Fed’s February Meeting

We’ve seen significant events since the Fed’s last meeting. On the one hand recent inflation data has been relatively concerning, suggesting that a larger hike could be coming.

However, the banking crisis has also served to tightened credit conditions in the Fed’s view, that lead to some potential for the Fed to hold rates steady as do potential further risks to the U.S. economy. Ultimately the Fed opted for a middle course making a 0.25-percentage-point rise in rates.


Banking Issues

As expected, the Fed projected confidence in the banking sector arguing that the main risks to Silicon Valley Bank were unique to the institution in terms of rapid growth, significant uninsured deposits and holding relatively long-duration fixed income instruments. However, a review is ongoing regarding Silicon Valley Bank and how regulatory processes could be improved. Chair Jerome Powell did mention that the digital bank-run was a relatively new phenomenon, making a rapid exodus of deposits possible, and mentioned that regulators would consider that topic.

Future Meetings

With no meeting scheduled for April, the Fed will meet again on May 3, market expectations are relatively evenly split between another 0.25-percentage-point rate increase and the Fed holding rates steady. The Fed expects to soon shift gears to holding rates at currently high levels in order to fight inflation rather than continuing to hike rates. However, markets take a different view and believe that economic weakness, including perhaps a recession, may soon force the Fed’s hand in cutting rates.

Source: Forbes

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