by Liz Ann Sonders, Chief Investment Strategist, and Kevin Gordon, Charles Schwab & Company Ltd.
Despite new threats from some instability in the banking sector, the Federal Reserve hiked the fed funds rate by 25 basis points in March, while still focusing on combating inflation.
Importantly, the FOMC's statement said that the "U.S. banking system is sound and resilient," but also warned that "recent developments are likely to result in tighter credit conditions for households and businesses and to weigh on economic activity, hiring, and inflation," further noting that the "extent of these effects is uncertain." The statement was missing prior language about inflation having eased, instead noting that price pressures remain elevated alongside job gains that are "running at a robust pace." The statement also had no reference to the Russia/Ukraine war, which was mentioned in the prior statement.
Key statement change
Connecting the dots (and SEPs)
Source: Bloomberg, as of 3/22/2023.
The risk, of course, is that the economic growth threat is being underestimated, and the need to continue to combat (the lagging indicator that is) inflation is being overestimated. At the same time the Fed has opted to remain on its tightening path, it's highly likely that many banks—particularly small/regional banks—further tighten lending standards, contributing to elevated recession risk.
Source: Charles Schwab, Federal Reserve, as of 3/22/2023.
Note: Projections of change in real gross domestic product (GDP) and projections for both measures of inflation are percent changes from the fourth quarter of the previous year to the fourth quarter of the year indicated. PCE inflation and core PCE inflation are the percentage rates of change in, respectively, the price index for personal consumption expenditures (PCE) and the price index for PCE excluding food and energy. Projections for the unemployment rate are for the average civilian unemployment rate in the fourth quarter of the year indicated. Each participant's projections are based on his or her assessment of appropriate monetary policy. Longer-run projections represent each participant's assessment of the rate to which each variable would be expected to converge under appropriate monetary policy and in the absence of further shocks to the economy. The projections for the federal funds rate are the value of the midpoint of the projected appropriate target range for the federal funds rate or the projected appropriate target level for the federal funds rate at the end of the specified calendar year or over the longer run. 1For each period, the median is the middle projection when the projections are arranged from lowest to highest. When the number of projections is even, the median is the average of the two middle projections. 2Longer-run projections for core PCE inflation are not collected.
On to the presser
- Right up front, Powell noted that "serious problems at a small number of banks" have emerged.
- He also used "sound and resilient" to characterize the broader financial system.
- The "why" behind the Fed's liquidity support announcements is because those problems "if left unaddressed can undermine confidence in healthy banks."
- Powell said the programs are "effectively meeting" liquidity needs to date, but that they are monitoring the situation; while also noting that inflation remains too high and the labor market too tight.
- Wage growth has eased some, but overall labor demand still exceeds supply.
- Regarding inflation, "without price stability, the economy does not work for anyone" and that inflation imposes "significant hardship."
- In response to first reporter question about confidence if the banking crisis has been contained, Powell did mention an "internal review" being undertaken and that a pause in hike was considered at this week's meeting.
- The internal review is going to be "thorough and transparent" and that "it's clear that we really do need to strengthen supervision and regulation."
- Powell plans to "support the recommendations" of Michael Barr, the vice chair for supervision, who is leading the review of what happened with regulation of SVB, while also "welcoming outside probes of Fed oversight on SVB" and "independent investigations" on what happened with SVB.
- He emphasized that the banking system problems could amount to the equivalent of a rate hike (or more), but that it's too soon to make that judgement.
- In judging the need for additional tightening, the Fed will continue to analyze "incoming data" and "actual effects" from credit tightening.
- In response to a question about today's hike further exacerbating the banking system's woes, Powell replied that the Fed is focused on "macroeconomic outcomes."
- The statement's new language is meant to convey uncertainty over the banking problems on the economy; and that the effects could be modest, or there could be a more significant economic slowdown (in the latter case, the need for additional rate hikes would lessen).
- When asked if he would consider "alternatives" to rate hikes in firming policy, he replied that current "monetary policy tools" work.
- The impact of the turmoil among banks on credit tightening is likely to be "quite real," but it's premature to understand the full effects.
- With regard to SVB, Powell came right out and said the bank's "management failed badly."
- If the economy proceeds as policymakers expect, there "won't be a case" for rate cuts near-term.
- With regard to sufficiency of the Fed's reserves, Powell doesn't envision "running into reserves shortages."
- Powell made it a point to explain the difference between temporary balance sheet expansions that provide liquidity and longer-term programs that may be a part of monetary policy. Read: the recent expansion of the Fed's balance sheet should not be thought of as quantitative easing (QE).
- When asked about whether all bank deposits are now effectively protected, Powell responded that "you've seen that we have the tools to protect depositors" when there is a serious threat to the economy or financial system, and that "regulators will use those tools."
- Nearly simultaneous with those comments, however, was the release of a comment from Treasury Secretary Janet Yellen that they are "not considering a broad increase in deposit insurance."