The Federal Reserve raised its main interest rate above 5% but indicated that the rate may be raised because banking turmoil increases the risk of a recession in the United States. However, Federal Reserve Chairman Jerome Powell said that economic developments may require further tightening. The S&P 500 turned slightly lower as Powell spoke, as investors were unsure if the Fed’s long-awaited pivot had arrived.
Federal Reserve meeting policy statement
The Fed dropped language adopted at the May meeting that “some additional policy might be appropriate.” In its place, the Fed’s new meeting statement said policymakers would “closely monitor the information received and assess its implications for monetary policy.”
The Fed has not ruled out further rate hikes or explicitly announced a pause. However, simply confirming that he is no longer inclined to hike rates further could be interpreted as an intention to be dovish – barring a major inflation surprise.
The combination of a quarter-point rate hike today and the removal of the tightening bias adds up to what economists call a “cautious rally.”
However, Powell’s message was not entirely pessimistic. While he said the Fed’s key interest rate may be in the right place, he made it clear that the choice is whether to hold it steady or raise it further. In other words, cuts in interest rates aren’t even close.
Ahead of today’s Fed meeting, Nomura economists Aichi Amemiya and Jacob Meyer wrote that they expect Powell to make clear that near-term rate cuts are unlikely, “spurring a reversal of current market pricing for two cuts of interest rates by the end of this year.”
Banking crisis grips the Fed
Powell said the banking sector is “healthy” and “conditions have broadly improved.” But he added that credit appeared to be contracting in a more serious way than usual.
If it weren’t for the banking crisis, the Fed would probably be intent on raising interest rates one or two times. After Powell’s hawkish testimony to the Senate on March 7, markets were betting that the Fed’s key interest rate could hit a range of 5.5% to 5.75%.
But Powell said after the Fed’s March 22 meeting that the credit tightening stemming from the banking crisis would essentially replace rate hikes, leaving monetary policy with “less work to do.”
At the time, Powell said it was just a guess as to how much a banking crisis would slow the economy. The latest batch of economic data continues to show that inflation is building too hard for the Fed and the job market remains very tight.
The Labor Department’s JOLTS report on Tuesday showed job vacancies decreased by 384,000 to 9.6 million in March. While this is down 15% since December, there are still 3.8 million more unemployed jobs. Payroll processor ADP on Wednesday estimated that the economy added a surprisingly strong 296,000 private sector jobs in April.
Powell noted that the job market remains “very tight.” There has been some softening, he said, but wage growth is still a few percentage points where it should be consistent with an inflation rate of 2%.
Bank stocks tumble
However, if Fed policymakers remain inclined to further tightening, that view may have gone out the window on Tuesday. Regional bank stocks took a hit as officials kicked off the two-day Federal Reserve meeting.
As of Monday afternoon, the markets were still pricing in roughly 30% odds of a Fed hike today and then again on June 14th. However, Tuesday saw the fallout continue for regional bank stocks, defying the FDIC’s hopes that First Republic Bank’s arranged sale to… c. B. Morgan Chase (JPM) would help stabilize the markets. Backwest Bancorp (PACW) decreased by 27.8% and Western Alliance Bancorp (WAL) 15.1%. Even the major regional banks have been grouped Comerica (CMA) decreased by 12.4% and KeyCorp (key) 9.4%.
By Tuesday afternoon, the odds of a June rate hike were down nearly 30% to zero.
Part of the blame lies with the Federal Reserve, which, having let inflation take its toll, then resorted to rapidly raising interest rates to contain it. Banks now have plenty of low-interest loans on their books, along with non-performing commercial real estate loans. However, banks have to struggle to hold on to their deposits by offering high interest rates on a savings account that can compete with money market interest rates of around 5%.
Standard & Poor’s 500 reaction to the Fed meeting
As Powell finished speaking at around 3:20 p.m., the S&P 500 was down 0.1% in stock market action on Wednesday. That reversed modest gains when the Fed’s policy statement was released at 2pm. Markets may have taken some comfort from Powell’s remark that he still believes the US economy can avoid a recession, but dismissed it after he questioned a rate hike later this year.
On Monday, the S&P 500 posted a rally to the February 2 high of 4,195 before reversing lower. The pause signal from the Federal Reserve has been greatly priced in. However, it may have prepared the S&P 500 for another attempt to breach the top of its trading range dating back to late August.
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