In a widely anticipated move the US Fed hiked the repo rate by 25 bps, thereby taking the federal funds rate target range to 4.75% to 5%. This job growth remains strong, the unemployment rate has remained low and the inflation remains elevated, but what has changed since the last FOMC meeting is the emergence of issues in the US banking sector. Thus, the wording of the FOMC statement was very keenly analysed to get a handle on the Fed’s take on the brewing banking crisis and its impact on the rate trajectory.
In this context the Fed fairly downplayed the markets’ concerns with regards to the banking crisis with a statement mentioning that “The U.S. banking system is sound and resilient.”
On the interest trajectory front the FOMC statement mentions that “The Committee anticipates that some additional policy firming may be appropriate”, signally that this may not be the final raise in the current hike cycle. Depending on the incoming data the Fed may effect one more rate hike if the inflationary data continued to remain hot. Having said that, there are emerging indications that the policy rates may be reaching a near term peak. The policy language has been tweaked marginally and the words “ongoing increases in the target range” have been replaced with “some additional policy firming.” The second important sentence in this context is “Recent developments are likely to result in tighter credit conditions for households and businesses and to weigh on economic activity, hiring, and inflation.” While the effects of the banking crisis would unfold over a period of time, the Fed expects this event to have an influence on lending rates by way of stringent lending standards.
The dot plot highlighting the future trajectory of policy rates is unchanged and still indicates one more rate hike in the pipeline. The FOMC members’ and street expectations align fairly well when it comes to the near term peak policy rates, whereas the divergence continues in terms of the timeline when the policy rates may be eased. The street expectations are still anchored towards a year end rate cut whereas the dot plot still indicates the FOMC members seeing a rate cut only in 2024.
It would be difficult to predict the exact target range at which the Fed may take a pause, but we align with the street expectations that the existing rates are very near the peak. The key reason for this view is that the rates have been hiked at a very swift pace and from a very low level. The sudden rise of interest rates from a zero interest rate policy coupled with falling liquidity may create large disruptions in economic growth and the first domino has already fallen.
