Balancing act

Federal Reserve Chair Jerome Powell did his best version of Nik Wallenda today, walking the tightrope over concerns the central bank should pause tightening because of the recent stress in the banking sector and the Fed’s desire to battle inflation. Impressive because the market is still trying to push him off the wire.

It’s felt like a lot longer than 12 days from the last time we heard from members of the FOMC. Its mandated blackout period encompassed the spectacular failures of Silvergate, Silicon Valley, and Signature banks and the orchestrated bailout of Credit Suisse by UBS. Despite speculation to the contrary, the Fed raised the fed funds target range by 25 basis points to 4.75-5%. 

I viewed the meeting’s press conference as a challenge for Powell to explain why a hike was needed without causing the market to become unhinged. It could have interpreted a lack of rate action as a sign the Fed was indeed worried about the banking system. In the end, I needn’t have worried. Asserting that the bank failures were more isolated events, he revealed that the FOMC participants did consider a pause, but in the end they moved ahead because of their commitment to fight inflation. He said they are not clear how much the banking turmoil will impact financial conditions. They expect that the likely tightening of credit conditions stemming from the events could act as a pseudo rate hike, but don’t know to what extent. The statement replaced the reference to "ongoing rate hikes" with "some additional policy firming may be appropriate." That leaves the door open to more tightening, though not with as much conviction. 

Today’s meeting came with a new dot plot that looked an awful lot like the last one, with a similar projection of the terminal rate of 5.1% for year-end 2023. Fed funds futures contracts were unfazed, still reflecting that the next FOMC meeting in May could find policymakers raising the range by only a quarter-point and expecting policy easing beginning in the second half of this year. So, while Powell is traversing the chasm by saying the right things with a degree of humility, the markets simply don’t believe he will make it across . And if he does fall, it certainly won’t be a soft landing. 

There also was a case to be made for a pause in quantitative tightening, but the Fed stuck with its current plans to continue to significantly reduce the size of its balance sheet. Powell maintained that they have seen no signs of a reserve scarcity. The rates on the New York Fed Reverse Repo Facility and Interest on Reserves each moved up 25 basis points to 4.8% and 4.9%, respectively.