FOMC Review: No Pause After All?

By Dominique Dwor-Frecaut

Summary

• The Federal Reserve (Fed) hiked 25bp while two more banks emerged as resolution candidates.
• The Fed’s economic assessment was unchanged.
• Fed Chair Jerome Powell did not rule out a June hike and sees financial instability impacting Fed policy through a credit crunch, if at all.
• Based on current growth and inflation dynamics, I expect a hike in June barring a debt ceiling crisis.

Market Implications

• The market continues to under-price the Fed, starting with the June FOMC.

Unchanged Economic Assessment

The Fed hiked 25bp, in line with consensus and my expectations. The hike took place despite the resolution of First Republic Bank, the slide in regional banks equity prices and the emergence of Pacific Western Bank and Western Alliance Bank as the next candidates for resolution. On Wednesday, their share prices plunged 60% and 38%, respectively.

The Fed assessment of the economy was unchanged, namely the labour market remains very tight, inflation is well above target, and ‘the process of getting inflation back down to 2 percent has a long way to go.’

On the credit crunch, the Fed still thinks that ‘the economy is likely to face further headwinds from tighter credit conditions’ but ‘the extent of these effects remain uncertain.’ The?SLOOS?will be published on 8 May. However, the results were available to the FOMC ahead of the meeting, and Powell indicated that some mid-sized banks had been tightening their standards.

No Pause After All

The statement guidance was eased by dropping the sentence ‘the Committee anticipates that some additional policy firming may be appropriate…’ However, the statement retained a reference to ‘additional policy firming’ i.e., the statement did not indicate that the tightening cycle was over, which was my expectation.

During the presser, and contrary to my expectations, Powell did not rule out a further hike in June, stating that the FOMC remained ‘driven by incoming data meeting by meeting.’?He stressed that non-housing core services inflation had not ‘moved much’ and that disinflation would be gradual (March core PCE was 4.6%, compared with an end-2023 forecast of 3.6% in the March SEP). As a result, he did not expect rate cuts in 2023.

On the banking crisis, Powell said that ‘the three large banks that were at [the] heart of the stress we saw in early March have now all been resolved. The resolution and sale of First Republic was an important step toward drawing a line under that period of severe stress.’ In other words, Powell is not ruling out further instability but does not see it as impactful at a macro level, other than through a possible credit crunch with an uncertain impact on growth and inflation.

Market Consequences

The market underestimates the risk of a hike in June. Given growth and inflation dynamics, if the debt ceiling is resolved by the June FOMC meeting, I expect the Fed to hike. Since the Congressional Budget Office (CBO) sees a good chance of x-day in early June, resolution before the FOMC is a distinct possibility.

Also, as Powell stressed, rate cuts this year are inconsistent with the slow disinflation path envisaged by the FOMC.

Dominique Dwor-Frecaut?is a macro strategist based in Southern California. She has worked on EM and DMs at hedge funds, on the sell side, the NY Fed, the IMF, and the World Bank. She joined Macro Hive soon after its inception.