I no longer remember a Fed meeting when I wasn’t nervous beforehand, and the bated breath that preceded this one was at perhaps an all-time high. We can’t actually measure that so you’ll just have to take my word for it. Today, Jerome Powell walked a tightrope.
Expectations were for a 25 basis-point hike, and a 25 basis-point hike we got. Despite the fact that expectations had less conviction than prior meetings, the market seemed relatively unaffected by this at first, only to fall pretty painfully into the red by the end of the day.
The most important messages we heard from Powell were how much of a threat recent events in the banking system pose to the financial system as a whole, and whether the Fed’s focus has shifted at all from fighting inflation to fighting the fear of contagion.
These two quotes from the statement and from Powell’s remarks (respectively) stood out to me:
“Recent developments are likely to result in tighter credit conditions for households and businesses and to weigh on economic activity, hiring, and inflation.”
“Without price stability the economy doesn’t work for anyone.”
He acknowledged that some pain was still to come, and that inflation remains the biggest enemy.
This was one of the special meetings where we got an updated dot plot and summary of economic projections from the Fed. Not a whole lot changed. The dots suggested roughly the same terminal rate as in December (5.13%), which would include one more hike that’s currently expected in May. The summary of economic projections didn’t move much either, making the data release rather anticlimactic.
The messages that remain in conflict with one another are what the market thinks the Fed will do with rates for the rest of the year, and what the Fed thinks it will do with rates for the rest of the year. Markets currently have at least two rate cuts priced in, whereas the Fed doesn’t project any cuts until 2024.
One of them is going to be wrong.
I think we’ll see at least one cut before year-end, despite the current strength in the labor market. Even if the banking woes have been contained and the deposit flight is over, I don’t think they’ll prove to be the only set of headlines that pose risks to the economy.
What might be more likely in coming months is some sort of credit problem as companies’ debt matures and they need to refinance their operations at much higher rates than before. Time will tell, but if I’m right and a cut occurs before year end, I think it will either be because something else broke, or economic data weakened notably.
For a long time in this cycle, credit spreads had barely moved. There was virtually no fear in the investment grade or high-yield space…until recently. These were obviously affected by the bank headlines, but if we use markets as forward-looking mechanisms, the increase in spreads portrays bumps ahead.
Firm Is the Word
One new development out of this meeting was the introduction of a new word: firming. Specifically, the Fed said some additional policy firming may be appropriate. I’m still trying to figure out exactly what that means, but it’s notable that they stopped using the word tightening and replaced it with firming.
At the very least, this confirms that we’re near the end of the hiking cycle. It’s even possible that this was the end of the hiking cycle. But now we begin the part where rates are held high while inflation is still an enemy.
This will test our economic stamina, the Fed’s resolve if more things “break,” and corporate resilience through a limited liquidity environment. The reversal in markets that occurred late in the session today was a big one, and something to pay attention to. Any bad news coming out of the economy will no longer serve as a warning, but a confirmation that things are on shaky ground. Stay defensive and diversified.
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