On Wednesday 22/03/2023, the Federal Reserve increased interest rates by 0.25%, signaling a shift to restrictive monetary policy due to tightened credit conditions and indications of financial instability following a disruption in the banking sector. The Federal Open Market Committee (FOMC) raised its benchmark rate to a range of 4.75% to 5% from its previous range of 4.5% to 4.75%. This marks the second consecutive quarter-point rate hike since the Fed’s reduction from a 50-basis point rate hike earlier this year. The Fed stated that it may need to implement further policy tightening to attain a sufficiently restrictive monetary policy that can return inflation to 2% over time.
The Fed maintained its benchmark rate forecast from December, predicting a terminal rate of 5.1% in 2023, indicating the possibility of at least one additional hike. The Fed’s inflation data has dominated its reaction function for months, with its employment goal playing second fiddle amid a strong labor market. However, the recent banking sector disruption has caused much uncertainty about the rate-hike path ahead.
According to the Fed, the collapse of Silicon Valley Bank and Signature Bank has impacted its monetary policy decision-making, and it acknowledged that tighter credit conditions could aid its fight against inflation. The Fed revised its inflation forecasts for this year and next year higher, stressing that further tightening was required to push monetary policy into restrictive territory. The core personal consumption expenditures price index, the Fed’s preferred measure of inflation, is estimated to climb to 3.6% in 2023, up from its previous projection of 3.5%. Inflation is expected to slow to 2.4% in 2024, compared to the previous forecast of 2.5%, while inflation forecasts for 2025 remain unchanged at 2.1%.
The Fed’s balance sheet has also become a topic of discussion, particularly after it began expanding again following jitters in the banking system. The Fed’s balance sheet is now valued at $8.6 trillion, up from $8.34 trillion last month. The shift from contraction to expansion in the Fed’s balance sheet resulted from an increase in funding costs and the central bank’s new bank lending facility designed to support the banking system. Banks now have access to loans of up to one year using qualifying assets, including underwater or below-par bonds, as collateral.
Traders are expected to focus on Powell’s press conference at 2:30 PM ET (19:30 GMT), with his messaging regarding the tug of war between inflation and financial stability likely to take center stage. Citi noted that the hawkish or dovish market read could hinge on whether Powell prioritizes financial or price stability in the press conference.