The Fed is messing around with the banking sector a bit
The outcome of Wednesday's FOMC meeting met expectations for a dovish hike but some questions still remain due to mixed messages regarding the banking sector. Analysis by Daleep Singh, Chief Global Economist, PGIM Fixed Income
The outcome of Wednesday's FOMC meeting met our (and the market's) expectations of a dovish hike, although more questions remain than answers. The least surprising part of the meeting was the cautious signal that accompanied the rate hike by 25 basis points towards a target of 4.75-5.00%: the Fed softened its guidance on further rate hikes – yes went from declaring “steady rate hikes will be appropriate” to “further monetary policy tightening may be needed”.
Furthermore, the peak rate envisaged by the FOMC projections was left unchanged at 5.25%, signaling that the end of the rate hike campaign is now upon us; Fed Chairman Powell acknowledged that a pause was being considered at this latest meeting. The statement also made clear, with particular emphasis from Chairman Powell at the press conference, that banking sector stress will weigh on growth, the labor market and inflation – in essence, a pretext for further rate hikes.
However, as we discuss recent developments in the banking sector, we cannot help but be perplexed by Fed Chairman Powell's continued emphasis that "all account holders are safe" when, at nearly the same time, Treasury Secretary Yellen told Congress that no-limit deposit insurance "isn't something we've considered." Without clear government coverage for uninsured account holders of medium-sized banks (more than 40% of total medium-sized banks in Q4 2022), the likelihood that tensions will continue and escalate remains high. Indeed, as Chairman Powell acknowledged, the magnitude and persistence of the banking sector shock to the real economy remains highly uncertain, casting doubt on the belief that no rate cuts will be needed this year. Our forecast remains that today's hike is likely to be the last of this cycle and that the long tail of the current banking sector shock will force the Fed into rate cuts of 50-75 basis points by year-end.
Markets focused on downsides
While markets were initially buoyed by the inclusion of downside risks in President Powell's assessment, including his attempts to reassure account holders, the optimism faded with the Treasury Secretary's Senate speech and exclusion almost simultaneously, of potential and large guarantees on deposits. After regional banks' troubles were revealed, equities fell sharply and credit spreads widened.
All of this bad news, however, has been nothing but good news for the Treasury market. While yields fell all along the curve, the Fed's focus on supporting growth and fading focus on fighting inflation, at least for now, led to a steepening of the curve, as short-term rates have fallen more than long-term rates.
Conclusions
Looking ahead, market movements will logically be driven by data and events. If the growth and inflation numbers turn out to be high and strong, risk markets will likely suffer as the Fed's leeway to combat banking stress with more favorable terms would be limited. Conversely, a moderation in growth and inflation – which looks likely given the tightening of credit conditions – should keep alive hopes of an end to central bank rate hikes and buy time for the banking sector to stabilise.
This is a machine translation from Italian language of a post published on Start Magazine at the URL https://www.startmag.it/economia/fed-tassi-settore-bancario/ on Sat, 25 Mar 2023 06:10:16 +0000.