On March 22 the Federal Reserve will announce it update Fed Funds target. Markets suspect a 0.25 percentage point rise as most likely, with a slightly smaller chance of holding rates steady. However, this Fed meeting is relatively uncertain when compared to most in recent years.
The inflation picture has deteriorated since the Fed’s last meeting, but banking issues may dominate. There is still concern that inflation is well above the Fed’s target and not falling fast enough. However, the banking crisis adds complexity to the Fed’s analysis. It doesn’t allow the Fed to deal with inflation in isolation any longer.
Markets believe that if a hike does come in March it could be the last, as recession fears may then force the Fed’s hand in cutting rates. That’s a new perspective. Previously, markets saw a few more hikes into the summer. However, it’s less probable the Fed will forecast a recession so directly, and may remain more focused on the inflation fight until economic evidence of a recession emerges. It recent discrepancies between the Fed and markets in forecasting rates, the Fed has normally prevailed. However, a recession might change that.
The banking crisis complicates the picture further. Silicon Valley Bank, Signature Bank and Silvergate Bank have all failed, and First Republic and Credit Suisse required support. Market confidence in the banking sector remains relatively low and on March 19 the Fed announced coordinated international liquidity, which acknowledged “strains” in global funding markets. That complements domestic support for banks announced a week previously on March 12. Global banking issues will likely evolve even over the remaining hours until the Fed meets.
On the one hand, the Fed’s provision of liquidity to ease risks to banks domestically and internationally has offset some of the Fed’s recent work in shrinking its balance sheet via quantitative tightening. So regardless of where rates move, arguably monetary policy, when considered holistically, is now materially looser than it was at the last meeting.
Also, the Fed’s March rate move may signal the wealth of private information it has on the banking sector. Raising rates would normally interpreted negatively, all else equal. Yet, it may also signal some degree of confidence from the Fed that the banking crisis may not worsen from here. If it signals that the Fed is perhaps less concerned about the banking crisis, then a rate hike may, ironically, be considered good news.
Holding rates steady would be welcomed by markets, but also begs the question of what additional banking data the Fed is seeing that necessitates such a change in policy from Fed Chair Powell hinting at a large 0.5 percentage point hike in rates not even two weeks ago, before major banking issues surfaced. As such looser policy may be viewed more as a signal that the risks to the banking sector are not over.
With the March rate announcement, the Fed will also release rate projections for 2023 and beyond. These will be examined to see how the Fed’s assessment has changed from the most recent release of these forecasts last December. Again earlier this month, further hikes seemed likely, and the Fed may maintain this position, but markets now see a clear chance of rate cuts in 2023. That’s something prior comments from Fed officials was suggested was off the table.
The Fed under Chair Jerome Powell has always sought to emphasize the data dependence of its policy decisions. That’s perhaps no more true than this week, as inflation remains elevated, but risks to the banking sector present clear risks that could change the trajectory of the broader economy. That means the upcoming Fed decision is more uncertain than most recent meetings and markets could move more on the Fed announcement than is typical. Markets may also look past the actual decision on rates to what it signals regarding the Fed’s confidence in U.S. and international banks.