Fed opts for a 25bps hike, taking the Fed Funds target range to 4.75-5%; softens policy guidance as tighter credit conditions will weigh on activity and inflation

Initial market reaction to the latest Fed policy update has been lower rates, modestly stronger equities and a weaker USD.  The Fed opted for a dovish 25bps hike, as widely anticipated, but ahead of the meeting there was some uncertainty about how the Fed would proceed in the face of recent turmoil in the banking sector.

So after much speculation about what the Fed would do today, it hiked by 25bps to take the Fed Funds target range to 4.75-5%. The statement inserted a new paragraph saying “The US banking system is sound and resilient. Recent developments are likely to result in tighter credit conditions for households and businesses and to weigh on economic activity, hiring, and inflation. The extent of these effects is uncertain. The Committee remains highly attentive to inflation risks.” And with that, forward guidance on the policy outlook was softened – replacing prior language on ongoing increases in rates to “closely monitor incoming information…the committee anticipates that some additional policy firming may be appropriate”. The Fed will continue at the same pace on QT.

There was little change to the median Fed Funds projection illustrated by the dotplot, with the 2023 figure left at 5.125%, implying one more hike this cycle. The 2024 median was lifted by just 0.125% to 4.25% and the 2025 and long-run medians were left at 3.125% and 2.5%. There was also little change in the dispersion of these projections, and they encompass a wide range of views on the committee. Forecast revisions to inflation and the unemployment rate were insignificant.

As we go to print, Fed Chair Powell has begun his press conference, but the initial market reaction suggests a modest dovish surprise.  US Treasury yields have pushed lower and the market sees a near-even chance of one more rate hike this cycle, and increasing chance of easier policy thereafter.  Powell said that the committee considered a pause in the days running up to the meeting and noted that a significant group on the FOMC expected credit tightening.

The USD is broadly weaker, with the DXY index down 0.7% on the day.  Being one of the better performers, the NZD is up over 1% to 0.6275 and is higher on the crosses, reversing underperformance earlier this week. The AUD is up to 0.6750, EUR is heading towards 1.09. We won’t labour on market movements as they are changing rapidly as Powell is speaking.

The S&P500 is modestly stronger, with Financials and Real Estate sectors underperforming. Focus turned to PacWest Bancorp, a smaller regional bank, which reported a fall of $6.8b in customer deposits to $27.1b (down 20%) since the start of the year. It also reported having tapped the Fed’s borrowing facilities to the tune of $12.6b and $3.7b from the FHLB.

UK CPI inflation data for February were 0.5 percentage points ahead of consensus at 10.4% for headline and 6.2% for core inflation respectively, both measures picking up from the prior month. Services inflation jumped up to 6.6% y/y, with higher wages inflation feeding through. While inflation is projected to head much lower from here, the market moved towards more conviction in a 25bps rate hike from the BoE tonight, with pricing for the meeting shifting from +14bps to +23bps. UK gilts showed a significant flattening bias, with the 2-year rate up 22bps and the 10-year rate up 9bps. 

The domestic rates market continued to get whipped around by global forces, with NZGBs up 8-12bps across the curve and swaps up 12-14bps. Consumer confidence remained depressed on the quarterly Westpac index, with an insignificant lift to 77.7, leaving it near a record-low level.

In the calendar ahead, as noted the Bank of England meets tonight where the market is now more convicted in a 25bps hike than a pause decision after the shockingly strong inflation data overnight. Elsewhere there are only second-tier economic releases.