Produced by: Wall Street Insights Written by: Du Yushi
On Wednesday, March 22, the Federal Reserve raised interest rates by 25 basis points as scheduled, raising the benchmark federal funds rate to a target range of 4.75%-5%, the highest level since September 2007, on the eve of the financial crisis.
This is the ninth consecutive rate hike by the Federal Reserve since March last year, and the second consecutive rate slowdown to 25 basis points. After the resolution was released, the market continues to expect that the U.S. interest rate hike cycle is coming to an end, and that interest rates may be cut to 4.19% before the end of this year to cope with the economic slowdown.
Big change in the wording of the statement: Added warning of the impact of the banking crisis, adding flexibility to suspend interest rate increases in the future
The resolution deleted the sentence that the conflict between Russia and Ukraine "is causing great human and economic difficulties and exacerbating global uncertainty", saying that consumer spending and production "grew modestly", employment growth "recovered in recent months and is running at a strong pace", unemployment remains low, and inflation remains high. The description of inflation deleted the wording "inflation has eased somewhat".
Some analysts believe that this statement suggests that the Fed's interest rate hike cycle is nearing its end because it deleted the "ongoing increases will be appropriate" in the past eight statements and replaced it with "some additional policy firming may be appropriate", adding the flexibility to suspend interest rate hikes.
The statement also added an interpretation of the recent banking crisis. In addition to adding that "the committee will closely monitor future information releases and assess their implications for monetary policy", it also reiterated that "it is prepared to adjust its policy stance appropriately if necessary":
"The U.S. banking system is sound and resilient, and recent developments could lead to a tightening of credit conditions for households and businesses and weigh on economic activity, job hiring, and inflation. The magnitude of these effects is uncertain. The Committee remains highly focused on inflation risks."
It is worth noting that the decision to raise interest rates by 25 basis points was unanimously supported by the voting committee. Earlier, there were rumors that the newly appointed Chicago Fed President Austan Goolsbee might ask the Fed to stand pat, but this did not happen.
At the same time, the statement shows that the Fed's attitude towards fighting inflation has not changed. In addition to describing "inflation remains high", the Fed remains "firmly committed to restoring the 2% inflation target" and will achieve this by obtaining a "monetary policy stance that is sufficient to restrict economic growth."
In addition, the Fed also raised the reserve balance interest rate by 25 basis points to 4.90% and the discount rate to 5%, both in line with expectations; it will continue to shrink its balance sheet at the same pace, that is, up to $60 billion in U.S. Treasury bond principal will mature and no longer be invested each month, and up to $35 billion in mortgage-backed securities will be rolled off the balance sheet after maturity.
Many analysts pointed out that the resolution statement showed that the Federal Reserve will continue to raise interest rates, but it showed a cautious tone towards the recent banking crisis. Officials have increased their concerns about the risks of economic downturn, and the overall wording of the statement has softened, all of which suggest that the interest rate hike cycle is about to end.
However, the statement also indicated that it was too early to judge the extent to which banking stress would slow economic growth. The emphasis on high inflation may indicate that the Fed currently believes that price pressures are a greater threat to economic growth than bank turmoil.
The “dot plot” did not change the interest rate forecast for the end of this year to 5.1%, suggesting that there is only room for one more 25 basis point rate hike.
The argument supporting the idea that the Fed is nearing the end of its rate hike cycle is also reflected in the “dot plot” that reflects officials’ opinions on interest rates.
Officials' median expectation remains that the U.S. peak interest rate will be 5.1% in 2023, the same as in December last year; the interest rate expectation for the end of 2024 rose to 4.3% from 4.1%, and the expectations for the end of 2025 and longer-term interest rates remained unchanged at 3.1% and 2.5%, respectively.
The forecast of 5.1% interest rate this year indicates that the Fed may only have room to raise interest rates once more, and by 25 basis points. Ten of the 18 officials supported this view, an absolute majority, and another seven believed that the interest rate should exceed 5.1%.
Some analysts said that compared with the forecast for this year, the dot plot expectations for the next two years show considerable differences among officials. But the median expectation shows that interest rates may fall by 0.8 percentage points in 2024 and 1.2 percentage points in 2025.
After the decision was released, the FedWatch tool of the Chicago Mercantile Exchange CME showed that the probability of the Fed staying on hold in May rose to 53% from 36% a day ago, and the probability of raising interest rates by 25 basis points fell from 60% to 47%. The interest rate swap market showed that traders expected a rate cut to 4.19% by the end of the year. This means that the market's expectations for interest rates are more dovish than the outlook of Fed officials.
Some commentators said that there was a huge gap between the bets on the "dot plot" and the overnight swap index OIS, indicating that the market believed that the Federal Reserve would enter a rate cut cycle earlier than it expected, or end the rate hike action faster. The market believed that there might be as many as two rate cuts this year.
Ashish Shah, chief investment officer of Goldman Sachs' public investing business, said the bank chose to downplay the importance of the latest "dot plot" and economic forecasts in such a rapidly changing environment because there is considerable uncertainty about the future.
The Fed lowered its GDP forecast for this year and next year, further raised its core inflation forecast for the same period, and kept its unemployment rate forecast stable
In its quarterly economic forecast update, the Fed lowered its forecast for U.S. economic growth this year and next, especially for next year:
The US GDP growth forecast for 2023 was lowered to 0.4%, compared with an expected increase of 0.5% in December last year.
The US GDP growth forecast for 2024 was lowered to 1.2%, compared with an expected increase of 1.6% in December last year.
The US GDP growth forecast for 2025 was raised by 1.9%, compared with an expected increase of 1.8% in December last year.
The longer-term US GDP growth forecast is 1.8%.
The Fed also lowered its unemployment rate forecast for 2023:
The unemployment rate forecast for 2023 was lowered to 4.5%, from 4.6% in December last year;
The unemployment rate is expected to be 4.6% in 2024, the same as in December last year;
The unemployment rate forecast for 2025 was raised to 4.6%, compared with 4.5% in December last year;
The long-term unemployment rate is expected to be 4.0%, the same as in December last year.
At the same time, the Fed further raised its nominal PCE inflation forecast for this year and its core inflation forecast for this year and next year:
The PCE inflation forecast for 2023 was raised to 3.3%, compared with 3.1% in December last year.
PCE inflation is expected to be 2.5% in 2024, the same as in December last year.
PCE inflation is expected to be 2.1% in 2025, the same as in December last year
Maintain the longer-term PCE inflation forecast unchanged at 2.0%.
The core PCE inflation forecast for 2023 was raised to 3.6%, compared with 3.5% in December last year.
The core PCE inflation forecast for 2024 was raised to 2.6%, compared with 2.5% in December last year.
Core PCE inflation is expected to be 2.1% in 2025, the same as in December.
