March 22, 2023
Good morning,
It’s Fed day with a Fed that is truly stuck in the middle. It’s clear that the Fed’s restrictive policies are causing instability in some pockets of the financial sector. At the same time, there’s plenty of reason to believe that other parts of the economy are in a state where policy is not restrictive enough. Even though the labor market has loosened somewhat, it remains historically tight. Last week’s CPI report showed that inflation remains sticky, and the downward path is questionable. Rates likely have varying levels of restrictiveness depending on the sector in question. Complicating matters, the restrictive rate for financial stability could differ from that for macroeconomic stability (controlled inflation). The Fed has a dual mandate; maintain both. Each mandate is pushing the Fed in opposite directions today.
Interest rate future markets are overwhelmingly expecting a +25 bps hike today. Market expectations for future rate hikes, and rate cuts for that matter, have been careening between the widest of extremes to render them useless for now as any kind of predictive tool. It would seem that the market is giving the Fed a free pass on a +25 bps hike today. In addition, the Fed has last week’s ECB (European Central Bank) rate hike playbook: hike rates, talk tough on inflation, but don’t commit to any forward guidance and repeat that you are data dependent.
And then there is QT (Quantitative Tightening}. Expanding and contracting the balance sheet at the same time is confusing. Temporarily suspending QT until financial stability is restored seems prudent.
In sum, it is likely that the Fed will tighten further today (+25 bps.). However, given the rising financial risk, they are unlikely to be as demonstrative about near-term rate hikes as they were only two weeks ago when testifying in front of Congress. Today, more so than past meetings, appropriate communication will be critical to restoring confidence.
Be well,
Mike