The Federal Reserve raised its key interest rate by a quarter-point on Wednesday to the highest level in 16 years, but signaled that it may now pause the streak of 10 rate hikes.
In an overt shift, the central bank no longer says it “anticipates” further rates will be needed, only that it will watch incoming data to determine if more hikes “may be appropriate.”
The Fed downplayed prospects of interest rate cuts by the end of this year - even while not ruling it out.
At the press conference following the release of the FOMC statement, Chair Jerome Powell said the Fed still views inflation as too high and said high price pressures remain a matter of concern for the central bank. Because of that, Powell said it’s too soon to say the rate hike cycle is over.
In the wake of the announcement, stock markets held to modest gains, but selling pressure emerged in the final hour of trading and Wall Street closed lower. Bond yields immediately slipped, with the US two-year - which is sensitive to Fed Reserve policy decisions - down by 9 basis points at 3.89% by late afternoon. The U.S. dollar weakened immediately after the Fed policy decision, but quickly recovered.
Traders are betting the Fed will indeed be on hold for at least its next two policy meetings in June and July, before beginning to ease policy later this year. Credit markets are currently pricing in 50 basis points of cuts in the Fed policy rate by this December.
Interest rate move probabilities based on swaps trading in credit markets held steady for Canada as well, pricing in a 25 basis point cut in interest rates by the Bank of Canada by the end of this year. In recent weeks, markets have been swinging between placing bets that there will be no further changes to the BoC policy rate for the rest of this year - or 25 to 50 basis points worth of easing by year end.
Here’s how money markets are pricing in further moves in the Bank of Canada overnight rate for this year as of 320pm ET Wednesday, according to Refinitiv Eikon data. The current Bank of Canada overnight rate is 4.5%. While the bank moves in quarter point increments, credit market implied rates fluctuate more fluidly and are constantly changing.
Here’s how economists are reacting:
Royce Mendes, Managing Director & Head of Macro Strategy at Desjardins Capital Markets
It’s clear from Jay Powell’s press conference that the Fed is very unclear about what comes next. After raising rates 25bps today, officials have yet to decide whether it’s time to pause. In fact, the Chairman unequivocally stated that no decision on a pause was made today. But, by removing the explicit forward guidance regarding the need for higher rates, policymakers certainly aren’t saying that higher rates are necessary either. The non-committal nature of the statement speaks to the degree of uncertainty about the evolution of inflation and financial system stress and also likely to disagreements among FOMC members.
Powell confirmed that officials simply don’t know whether rates are sufficiently restrictive. While the statement removed the part about needing to raise rates further to get them to be sufficiently restrictive, that’s not the Fed’s way of communicating that interest rates are now high enough to do the job. The Chairman said that it will be an ongoing assessment to determine whether or not further hikes are required and he wouldn’t even agree that the bar was higher to raising rates now. That said, Powell did imply that his rough estimate of the real policy rate is 2%, which is materially higher than most estimates of a neutral rate. So they’re clearly restrictive. But sufficiently so? That’s an open question.
If the committee is tilting one way or another, they’re keeping their cards close to their chest. Treasury yields are a few basis points lower following the press conference, but that’s hardly a definitive move. With the market not gleaning much information from the statement or press conference, individual Fed speakers and upcoming data have the ability to swing the odds in either direction. We tend to believe that upcoming data will support a pause in rate hikes beginning at the next meeting.
David Rosenberg, founder of Rosenberg Research
In the midst of a regional banking sector crisis and what has turned out to be a relentless decline in oil prices (which is going to end up feeding into everything), not to mention being on the precipice of a debt-ceiling fiasco, the Fed went ahead and hiked the funds rate by 25 basis points today to a 5.0%-5.25% range, now at the peak level posted in the 2003-06 tightening cycle. No other Fed has ever tightened policy this close to a possible debt default, and only once (1984) did the Fed ever tighten into a financial crisis of any kind (and Volcker ended up reversing those rate hikes very quickly and substantially). There were no dissents even though recent remarks by Austan Goolsbee and Lisa Cook suggested that their preference was for a pause. That said, the pause likely becomes official at the next meeting on June 14th . To placate the hawks on the FOMC, the statement still reads as though it had a de facto “tightening bias,” but the language shifted just enough to suggest that, going forward, the bar has been raised on any further rate increases. ...
This one line, brand spanking new, was planted for one reason, which was to signal a pause without having to suffer any embarrassment by making it clearer. This is how the Fed talks — in syntax. To wit: “In determining the extent to which additional policy firming may be appropriate to return inflation to 2 percent over time […]” The words “determining” and “may” tell the tale, keeping in mind that the Fed always talks and moves incrementally. My reading of this statement is that a lot has to happen to get the Fed to tighten again — we need to see surging payrolls, renewed wage acceleration, no signs of credit constraint coming from this banking sector imbroglio, and inflation either levelling off or going back up. The Fed never signals a pause directly at the turn in the rates cycle and always maintains some sort of tough language. But at the turn there is just enough of a shift in the language that leaves the door open for doing nothing at the next meeting. That is exactly what we saw today.
James Orlando, director and senior economist with TD Economics
Although the Fed’s statement keeps the door open to further hikes, markets think that the Fed is done. The knee-jerk reaction to the announcement was a drop in Treasury yields and a depreciation in the U.S. Dollar. Markets are looking for the Fed to remain on hold through the summer before starting to cut rates as early as September. ... Although we too think the Fed is likely done with further rate hikes, we think September is too early for cuts. Given the lagged effects of the Fed’s past rate hikes and recent tightening in financial conditions, we think rate cuts are more likely to start at the very end of 2023 or early 2024.
Avery Shenfeld, chief economist, and Katherine Judge, senior economist, with CIBC World Markets
This is a hawkish pause, as the committee says it will be looking for signals on the need for additional firming, rather than a balanced statement that would have referenced potential moves in either direction. Similarly, the statement highlighted that policymakers are “highly attentive” to inflation risks, with no similar statement on recession risks. When asked about recession risks, Powell said that it was his view that the economy would still see modest growth over the rest of the year, and he therefore does not foresee a recession. But if, as we expect, Q2 sees little or no growth, and inflation signals continue to moderate, the May hike should prove to be the last for this cycle, with the first easing not likely until 2024, as we’ll also need time for inflation pressures to sufficiently abate. Two-year yields are modestly lower ... relative to just ahead of the statement, with the market ignoring the slight hawkish bias and retaining the view, which we don’t share, that we’ll see rate cuts before the end of the year.
Taylor Schleich, Warren Lovely & Jocelyn Paquet, economists with National Bank Financial
The headline decision had been pretty well telegraphed, but it was really all about the guidance given at today’s meeting as the end of the tightening cycle had come into focus. By discarding the line that “some additional policy firming may be appropriate”, it appears that a pause is the preferred policy prescription from here out. That was the sense we got in Chair Powell’s press conference too. Yes, it’s fair to say that they’ve technically retained a hiking bias but Powell’s pledge to do more if needed felt somewhat superficial. To us, the bar for further hikes is now quite high and the consensus path for the economy/inflation is likely to be consistent with the FOMC remaining sidelined for much of this year. Indeed, we do not expect a hike at the next meeting in June. Increasingly the focus will and should shift to rate cuts. Powell spoke to this in the press conference and made it clear that, should the Committee’s economic/inflation forecast materialize, rate cuts would not be appropriate this year. However, our growth outlook is weaker, and we foresee faster disinflation than Fed policymakers. That environment might just be consistent with rate cuts starting very late this year, but we feel that market expectations for easing as soon as September may be too aggressive.
Andrew Hunter, deputy chief US Economist, Capital Economics
Despite the renewed wave of concern over the health of regional banks, following the failure of First Republic, the statement language on the banking sector was little changed, with officials still believing that the economic impact of the turmoil “remains uncertain”. Alongside the direct impact of the 500bp increase in the fed funds rate over the past year, we continue to expect a tightening in credit conditions to drive a much sharper downturn in the economy than the Fed is allowing for. With labour market conditions already cooling, that should in turn help drive a more rapid decline in core inflation than officials expect. As a result, we still think the Fed’s next move will be an interest rate cut later this year, with rates eventually falling back more sharply than the markets are anticipating.
Geoff Phipps, portfolio manager and trading strategist at Picton Mahoney Asset Management
By and large, Powell reinforced a ‘comfortable’ view of the state of the overall economy, including the current lending and deposits environments. He reiterated several times that his outlook for recession was biased to the mild side, if any, and that views that may be held by certain members of the Fed staff that are direr should be discounted.
Another theme from this rate decision was the consistent pushback against the idea of rate cuts in 2023. The overarching view from Powell is that inflation will fall slowly, so the base case is that it is not appropriate to cut rates until the data changes. And while it is possible for the data to change rapidly, it will require a high level of certainty that the changes in data are reflective of sustainable and real changes in the economy. In other words, the bar is high for the Fed.
Edward Moya, senior market analyst, The Americas, OANDA, a forex trading firm
The Fed’s tenth straight rate hike will likely be the last one in this cycle. The Fed is concerned that tighter credit conditions will weigh on economic activity and hiring, while helping maintain disinflation trends. Credit tightening is about to cripple the economy and it appears that as long as we don’t get a perfect storm of hotter-than-expected labor and inflation data, the Fed will keep rates on hold for at the very least till the end of the year.
The lag with shelter prices and weakening economic activity should assure inflation will fall below 4% before the end of summer, possibly making a run at the 3% handle. The Fed should be in a position to keep a lengthy hold until early next year.