FOMC to end tightening cycle in response to US banking crisis

FOMC to end tightening cycle in response to US banking crisis US Fed raised fund rate by 25bps and expects to lower GDP forecast for 2024

By Ahmed Azzam | @3zzamous | 23 March 2023

Preview of FOMC meeting-1
  • Fed raised its target range for the federal funds rate by 25 bps, fastest pace since 1980s.

  • FOMC optimistic about economy but notes tighter credit conditions could impact activity.

  • FOMC suggests end of tightening cycle is near.

  • Median 2023 dot in "dot plot" only 25 bps higher than current rate, predicts extended pause in future meetings.

FOMC hikes fund rate to fastest pace since 1980s

The Federal Open Market Committee (FOMC) has made a unanimous decision to increase rates by 25 basis points, pushing the target range for the federal funds rate to 4.75% - 5.00%. This marks the Committee's ninth consecutive rate hike, totaling 475 basis points over the past 12 months and the fastest pace of tightening seen since the early 1980s. In addition, the FOMC has chosen to maintain the present pace of quantitative tightening, enabling the monthly roll-off of up to $60 billion of Treasury securities and $35 billion of mortgage-backed securities from its balance sheet. This verdict did not come as a surprise to financial markets.

FOMC optimistic despite elevated inflation and banking system strain

In the latest statement, the FOMC has maintained its optimistic stance on the economy. As per the statement, recent indicators suggest moderate growth in spending and production, and job gains continue to be robust. However, inflation still remains elevated. The Committee also acknowledged the recent strain on the banking system, which is likely to cause tighter credit conditions for households and businesses, leading to a negative impact on economic activity, hiring, and inflation. The extent of these effects is uncertain, according to the FOMC.

US Fed responds to bank turmoil by adjusting stance

In light of recent turmoil in the banking system, the FOMC has adjusted its stance on further tightening. While previous statements suggested ongoing increases in the target range would be necessary to achieve a restrictive monetary policy and return inflation to 2 percent, the FOMC now sees the need for only "some additional policy firming." Chairman Powell acknowledged the possibility of a pause in the tightening cycle during his post-meeting press conference, as uncertainties and the likelihood of tighter credit conditions weigh on economic activity, hiring, and inflation. This shift in forward guidance suggests that the end of the tightening cycle is on the horizon.

During its regular quarterly update of macroeconomic forecasts, the FOMC released its Summary of Economic Projections (SEP) which includes the "dot plot" of individual member assessments on the appropriate level of the fed funds rate over the next few years. The median dot for the end of this year remains in the 5.00%-5.25% range, unchanged from December, although it would have been higher if not for recent banking system strains. The FOMC also lowered its GDP growth forecast for 2024 by 0.4 percentage points to 1.2% to reflect the impact of "tighter credit conditions" resulting from the current banking system strains.

Rate-hike cycle likely to increase in May meeting

According to Fed tone, the Federal Open Market Committee (FOMC) is expected to implement a 25 basis-point increase in the federal funds rate range at its upcoming May 3rd meeting, marking the conclusion of the current rate-hike cycle. While the FOMC is anticipated to refrain from further rate increases on June 14th to evaluate the impact of tighter monetary policy and credit conditions, caution that their fed funds forecast is biased towards upside risks. Put simply, should the recent turbulence in the banking system stabilize, there is a greater likelihood of another rate hike on June 14th. The Committee is expected to maintain rates at their present level for the majority of 2023 as inflation continues to decline and economic activity moderates. Nevertheless, if the prediction of a mild recession commencing in Q3 materializes, they opine that the FOMC will significantly reduce rates in 2024.