The Federal Reserve still raised interest rates by 25 basis points despite the banking woes. But not because it has high confidence that all will be well. Moreover, by not pausing once, it has again misled the market.
Although the Dot Plot has a somewhat questionable role as a signal of future Fed policy, in this cycle it is a useful tool to convince markets during 2023 that interest rates should be raised further. So that the median ‹dot› has not gone up, despite the many signals prior to the escalation in the US banking sector, says enough about how much uncertainty exists among Fed members.
How then?
In Wednesday’s press conference, Powell indicated that his colleagues and he are collectively wondering how this could have happened and that an investigation will follow. Apparently, there were signals from the Fed Supervisory Board that too little was ultimately done with. Good story!
In the official statement, the phrase ‹ongoing hikes will be appropriate› was replaced by ‹some additional policy firming may be appropriate›. This is because bank stress is very likely to lead to less favourable funding conditions, which will feed through in the same way as interest rate hikes.
Pause?
What surprises me is that the Federal Reserve has not taken a one-off pause with the clear message: ‹we don’t know, and because we need time to figure it out we will wait a while before the next interest rate hike.› Of course, this could give the impression that the Fed has panicked, but with Powell’s press conference still on the mind, it is not much different now.
Incidentally, the inflation figures are still screaming for further rate hikes. All inflation measures that the Fed holds dear have risen in the last two months on a three-month annualised basis. But in case of a full-fledged banking crisis, this will obviously come to an end soon. Should it be nipped in the bud - I think more liquidity will have to be added - Powell can proceed merrily from 3 May and, moreover, he will have more visibility on the tightening effect of less favourable funding conditions.
In my view, Powell has been able to remove little uncertainty regarding the unfolding banking crisis - of course, it is no surprise that a central bank proclaims that the financial system is sound - while adding uncertainty about future policy. Not least because, unless inflation surprises on the downside for once in the coming months, more interest rate hikes will have to be added.
Jeroen Blokland is founder of True Insights, a platform that provides independent research to build diversified multi-asset portfolios. Blokland was most recently head of multi-assets at Robeco. His chart of the week appears every Monday on Investment Officer.