Soaring debt and deficits causing worry about threats to the economy and markets

A view shows the U.S. Capitol in Washington, U.S., May 9, 2024. 

Kaylee Greenlee Beal | Reuters

Government debt that has swelled nearly 50% since the early days of the Covid pandemic is generating elevated levels of worry both on Wall Street and in Washington.

The federal IOU is now at $34.5 trillion, or about $11 trillion higher than where it stood in March 2020. As a portion of the total U.S. economy, it is now more than 120%.

Concern over such eye-popping numbers had been largely confined to partisan rancor on Capitol Hill as well as from watchdogs like the Committee for a Responsible Federal Budget. However, in recent days the chatter has spilled over into government and finance heavyweights, and even has one prominent Wall Street firm wondering if costs associated with the debt pose a significant risk to the stock market rally.

“We’re running big structural deficits, and we’re going to have to deal with this sooner or later, and sooner is a lot more attractive than later,” Fed Chair Jerome Powell said in remarks Tuesday to an audience of bankers in Amsterdam.

While he has assiduously avoided commenting on such matters, Powell encouraged the audience to read the recent Congressional Budget Office reports on the nation’s fiscal condition.

“Everyone should be reading the things that they’re publishing about the U.S. budget deficit and should be very concerned that this is something that elected people need to get their arms around sooner rather than later,” he said.

Uncharted territory for debt and deficits

Surging budget deficits have been driving the debt, and the CBO only expects that to get worse.

The agency forecasts a $1.6 trillion shortfall in fiscal 2024 — it is already at $855 billion through the first seven months — that will balloon to $2.6 trillion by 2034. As a share of GDP, the deficit will grow from 5.6% in the current year to 6.1% in 10 years.

“Since the Great Depression, deficits have exceeded that level only during and shortly after World War II, the 2007–2009 financial crisis, and the corona­virus pandemic,” the report stated.

In other words, such high deficit levels are common mostly in economic downturns, not the relative prosperity that the U.S. has enjoyed for most of era following the brief plunge after the pandemic declaration in March 2020. From a global perspective, European Union member nations are required to keep deficits to 3% of GDP.

The potential long-term ramifications of the debt were the topic of an interview JPMorgan Chase CEO Jamie Dimon gave to London-based Sky News on Wednesday.

“America should be quite aware that we have got to focus on our fiscal deficit issues a little bit more, and that is important for the world,” the head of the largest U.S. bank by assets said.

“At one point it will cause a problem and why should you wait?” Dimon added. “The problem will be caused by the market and then you will be forced to deal with it and probably in a far more uncomfortable way than if you dealt with it to start.”

Similarly, Bridgewater Associates founder Ray Dalio told the Financial Times a few days ago that he is concerned the soaring U.S. debt levels will make Treasurys less attractive “particularly from international buyers worried about the US debt picture and possible sanctions.”

So far, that hasn’t been the case: Foreign holdings of U.S. federal debt stood at $8.1 trillion in March, up 7% from a year ago, according to Treasury Department data released Wednesday. Risk-free Treasurys are still seen as an attractive place to park cash, but that could change if the U.S. doesn’t rein in its finances.

Market impact

Taxes will have to go up eventually to tackle the deficit, says Wolfe Research's Tobin Marcus

Net interest on the debt, which totals government debt payments minus what it gets from investment income, have totaled $516 billion this fiscal year. That’s more than government outlays for national defense or Medicare and about four times as much as it has spent on education.

The presidential election could make some modest differences in the fiscal situation. Debt has soared under President Joe Biden and had escalated under his Republican challenger, former President Donald Trump, following the aggressive spending response to the pandemic.

“The election could change the medium-term fiscal outlook, though potentially less than one might imagine,” Goldman Sachs economists Alec Phillips and Tim Krupa said in a note.

A GOP sweep could lead to an extension of the expiring corporate tax cuts Trump pushed through in 2017 — corporate tax receipts have about doubled since then — while a Democratic win might see tax increases, though “much of this would likely go toward new spending,” the Goldman economists said.

However, the biggest issue with the budget is spending on Social Security and Medicare, and “under no scenario” regarding the election does reform on either program seem likely, Goldman said.

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Banks are in limbo without a crucial lifeline. Here’s where cracks may appear next

The forces that consumed three regional lenders in March 2023 have left hundreds of smaller banks wounded, as merger activity — a key potential lifeline — has slowed to a trickle.

As the memory of last year’s regional banking crisis begins to fade, it’s easy to believe the industry is in the clear. But the high interest rates that caused the collapse of Silicon Valley Bank and its peers in 2023 are still at play.

After hiking rates 11 times through July, the Federal Reserve has yet to start cutting its benchmark. As a result, hundreds of billions of dollars of unrealized losses on low-interest bonds and loans remain buried on banks’ balance sheets. That, combined with potential losses on commercial real estate, leaves swaths of the industry vulnerable.

Of about 4,000 U.S. banks analyzed by consulting firm Klaros Group, 282 institutions have both high levels of commercial real estate exposure and large unrealized losses from the rate surge — a potentially toxic combo that may force these lenders to raise fresh capital or engage in mergers.  

The study, based on regulatory filings known as call reports, screened for two factors: Banks where commercial real estate loans made up over 300% of capital, and firms where unrealized losses on bonds and loans pushed capital levels below 4%.

Klaros declined to name the institutions in its analysis out of fear of inciting deposit runs.

But there’s only one company with more than $100 billion in assets found in this analysis, and, given the factors of the study, it’s not hard to determine: New York Community Bank, the real estate lender that avoided disaster earlier this month with a $1.1 billion capital injection from private equity investors led by ex-Treasury Secretary Steven Mnuchin.

Most of the banks deemed to be potentially challenged are community lenders with less than $10 billion in assets. Just 16 companies are in the next size bracket that includes regional banks — between $10 billion and $100 billion in assets — though they collectively hold more assets than the 265 community banks combined.

Behind the scenes, regulators have been prodding banks with confidential orders to improve capital levels and staffing, according to Klaros co-founder Brian Graham.

“If there were just 10 banks that were in trouble, they would have all been taken down and dealt with,” Graham said. “When you’ve got hundreds of banks facing these challenges, the regulators have to walk a bit of a tightrope.”

These banks need to either raise capital, likely from private equity sources as NYCB did, or merge with stronger banks, Graham said. That’s what PacWest resorted to last year; the California lender was acquired by a smaller rival after it lost deposits in the March tumult.

Banks can also choose to wait as bonds mature and roll off their balance sheets, but doing so means years of underearning rivals, essentially operating as “zombie banks” that don’t support economic growth in their communities, Graham said. That strategy also puts them at risk of being swamped by rising loan losses.

Powell’s warning

Federal Reserve Chair Jerome Powell acknowledged this month that commercial real estate losses are likely to capsize some small and medium-sized banks.

“This is a problem we’ll be working on for years more, I’m sure. There will be bank failures,” Powell told lawmakers. “We’re working with them … I think it’s manageable, is the word I would use.”

There are other signs of mounting stress among smaller banks. In 2023, 67 lenders had low levels of liquidity — meaning the cash or securities that can be quickly sold when needed — up from nine institutions in 2021, Fitch analysts said in a recent report. They ranged in size from $90 billion in assets to under $1 billion, according to Fitch.

And regulators have added more companies to their “Problem Bank List” of companies with the worst financial or operational ratings in the past year. There are 52 lenders with a combined $66.3 billion in assets on that list, 13 more than a year earlier, according to the Federal Deposit Insurance Corporation.

Traders work on the floor at the New York Stock Exchange (NYSE) in New York City, U.S., February 7, 2024.

Brendan Mcdermid | Reuters

“The bad news is, the problems faced by the banking system haven’t magically gone away,” Graham said. “The good news is that, compared to other banking crises I’ve worked through, this isn’t a scenario where hundreds of banks are insolvent.”

‘Pressure cooker’

After the implosion of SVB last March, the second-largest U.S. bank failure at the time, followed by Signature’s failure days later and that of First Republic in May, many in the industry predicted a wave of consolidation that could help banks deal with higher funding and compliance costs.

But deals have been few and far between. There were fewer than 100 bank acquisitions announced last year, according to advisory firm Mercer Capital. The total deal value of $4.6 billion was the lowest since 1990, it found.

One big hang-up: Bank executives are uncertain that their deals will pass regulatory muster. Timelines for approval have lengthened, especially for larger banks, and regulators have killed recent deals, such as the $13.4 billion acquisition of First Horizon by Toronto-Dominion Bank.

A planned merger between Capital One and Discovery, announced in February, was promptly met with calls from some lawmakers to block the transaction.

“Banks are in this pressure cooker,” said Chris Caulfield, senior partner at consulting firm West Monroe. “Regulators are playing a bigger role in what M&A can occur, but at the same time, they’re making it much harder for banks, especially smaller ones, to be able to turn a profit.”

Despite the slow environment for deals, leaders of banks all along the size spectrum recognize the need to consider mergers, according to an investment banker at a top-three global advisory firm.

Discussion levels with bank CEOs are now the highest in his 23-year career, said the banker, who requested anonymity to speak about clients.

“Everyone’s talking, and there’s acknowledgment consolidation has to happen,” said the banker. “The industry has structurally changed from a profitability standpoint, because of regulation and with deposits now being something that won’t ever cost zero again.”

Aging CEOs

One deterrent to mergers is that bond and loan markdowns have been too deep, which would erode capital for the combined entity in a deal because losses on some portfolios have to be realized in a transaction. That has eased since late last year as bond yields dipped from 16-year highs.

That, along with recovering bank stocks, will lead to more activity this year, Sorrentino said. Other bankers said that larger deals are more likely to be announced after the U.S. presidential election, which could usher in a new set of leaders in key regulatory roles.

Easing the path for a wave of U.S. bank mergers would strengthen the system and create challengers to the megabanks, according to Mike Mayo, the veteran bank analyst and former Fed employee.

“It should be game-on for bank mergers, especially the strong buying the weak,” Mayo said. “The merger restrictions on the industry have been the equivalent of the Jamie Dimon Protection Act.”

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The Federal Reserve may not cut interest rates just yet. Here’s what that means for your money

Economists expect the Federal Reserve to leave interest rates unchanged at the end of its two-day meeting this week, even though many experts anticipate the central bank is preparing to start cutting rates in the months ahead.

In prepared remarks earlier this month, Federal Reserve Chair Jerome Powell said policymakers don’t want to ease up too quickly.

Powell noted that lowering rates rapidly risks losing the battle against inflation and likely having to raise rates further, while waiting too long poses danger to economic growth.

But in the meantime, consumers won’t see much relief from sky-high borrowing costs.

More from Personal Finance:
Here’s when the Fed is likely to start cutting interest rates
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Deflation: Here’s where prices fell

In 2022 and the first half of 2023, the Fed raised rates 11 times, causing consumer borrowing rates to skyrocket while inflation remained elevated, and putting households under pressure.

With the combination of sustained inflation and higher interest rates, “many consumers are experiencing higher levels of economic stress compared to one year ago,” said Silvio Tavares, CEO of credit scoring company VantageScore.

The federal funds rate, which is set by the U.S. central bank, is the interest rate at which banks borrow and lend to one another overnight. Although that’s not the rate consumers pay, the Fed’s moves still affect the borrowing and savings rates they see every day.

Even once the central bank does cut rates — which some now expect could happen in June — the pace that they trim is going to be much slower than the pace at which they hiked, according to Greg McBride, chief financial analyst at Bankrate.

“Interest rates took the elevator going up; they are going to take the stairs coming down,” he said.

Here’s a breakdown of where consumer rates stand now and where they may be headed:

Credit cards

Since most credit cards have a variable rate, there’s a direct connection to the Fed’s benchmark. Because of the central bank’s rate hike cycle, the average credit card rate rose from 16.34% in March 2022 to nearly 21% today — an all-time high.

With most people feeling strained by higher prices, balances are higher and more cardholders are carrying debt from month to month compared with last year.

Annual percentage rates will start to come down when the Fed cuts rates, but even then they will only ease off extremely high levels. With only a few potential quarter-point cuts on deck, APRs would still be around 20% by the end of 2024, McBride said.

“If the Fed cuts rates twice by a quarter point, your credit card rate will fall by half a percent,” he said.

Mortgage rates

Fifteen- and 30-year mortgage rates are fixed, and tied to Treasury yields and the economy. But anyone shopping for a new home has lost considerable purchasing power, partly because of inflation and the Fed’s policy moves.

Rates are already significantly lower since hitting 8% in October. Now, the average rate for a 30-year, fixed-rate mortgage is around 7%, up from 4.4% when the Fed started raising rates in March 2022 and 3.27% at the end of 2021, according to Bankrate.

“Despite the recent dip, mortgage rates remain high as the market contends with the pressure of sticky inflation,” said Sam Khater, Freddie Mac’s chief economist. “In this environment, there is a good possibility that rates will stay higher for a longer period of time.”

Adjustable-rate mortgages, or ARMs, and home equity lines of credit, or HELOCs, are pegged to the prime rate, and those rates remain high.

“The reality of it is, a lot of borrowers are paying double-digit interest rates on those right now,” McBride said. “That is not a low cost of borrowing and that’s not going to change.”

Auto loans

Even though auto loans are fixed, payments are getting bigger because car prices have been rising along with the interest rates on new loans, resulting in less affordable monthly payments. 

The average rate on a five-year new car loan is now more than 7%, up from 4% when the Fed started raising rates, according to Edmunds. However, competition between lenders and more incentives in the market have started to take some of the edge off the cost of buying a car lately, said Ivan Drury, Edmunds’ director of insights.

Once the Fed cuts rates, “that gives people a little more breathing room,” Drury said. “Last year was ugly all around. At least there’s an upside this year.”

Federal student loans

Federal student loan rates are also fixed, so most borrowers aren’t immediately affected by the Fed’s moves. But undergraduate students who take out new direct federal student loans are now paying 5.50% — up from 4.99% in the 2022-23 academic year and 3.73% in 2021-22.

Private student loans tend to have a variable rate tied to the prime, Treasury bill or another rate index, which means those borrowers are already paying more in interest. How much more, however, varies with the benchmark.

For those struggling with existing debt, there are ways federal borrowers can reduce their burden, including income-based plans with $0 monthly payments and economic hardship and unemployment deferments

Private loan borrowers have fewer options for relief — although some could consider refinancing once rates start to come down, and those with better credit may already qualify for a lower rate.

Savings rates

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Powell reinforces position that the Fed is not ready to start cutting interest rates

Federal Reserve Chair Jerome Powell on Wednesday reiterated that he expects interest rates to start coming down this year, but is not ready yet to say when.

In prepared remarks for congressionally mandated appearances on Capitol Hill Wednesday and Thursday, Powell said policymakers remain attentive to the risks that inflation poses and don’t want to ease up too quickly.

“In considering any adjustments to the target range for the policy rate, we will carefully assess the incoming data, the evolving outlook, and the balance of risks,” he said. “The Committee does not expect that it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2 percent.”

Those remarks were taken verbatim from the Federal Open Market Committee’s statement following its most recent meeting, which concluded Jan. 31.

During the question-and-answer session with House Financial Services Committee members, Powell said he needs “see a little bit more data” before moving on rates.

“We think because of the strength in the economy and the strength in the labor market and the progress we’ve made, we can approach that step carefully and thoughtfully and with greater confidence,” he said. “When we reach that confidence, the expectation is we will do so sometime this year. We can then begin dialing back that restriction on our policy.”

Stocks posted gains as Powell spoke, with the Dow Jones Industrial Average up more than 250 points heading into midday. Treasurys yields mostly moved lower as the benchmark 10-year note was off about 0.3 percentage point to 4.11%.

Rates likely at peak

In total, the speech broke no new ground on monetary policy or the Fed’s economic outlook. However, the comments indicated that officials remain concerned about not losing the progress made against inflation and will make decisions based on incoming data rather than a preset course.

“We believe that our policy rate is likely at its peak for this tightening cycle. If the economy evolves broadly as expected, it will likely be appropriate to begin dialing back policy restraint at some point this year,” Powell said in the comments. “But the economic outlook is uncertain, and ongoing progress toward our 2 percent inflation objective is not assured.”

He noted again that lowering rates too quickly risks losing the battle against inflation and likely having to raise rates further, while waiting too long poses danger to economic growth.

Markets had been widely expecting the Fed to ease up aggressively following 11 interest rate hikes totaling 5.25 percentage points that spanned March 2022 to July 2023.

In recent weeks, though, those expectations have changed following multiple cautionary statements from Fed officials. The January meeting helped cement the Fed’s cautious approach, with the statement explicitly saying rate cuts aren’t coming yet despite the market’s outlook.

As things stand, futures market pricing points to the first cut coming in June, part of four reductions this year totaling a full percentage point. That’s slightly more aggressive than the Fed’s outlook in December for three cuts.

Inflation easing

Despite the resistance to move forward on cuts, Powell noted the movement the Fed has made toward its goal of 2% inflation without tipping over the labor market and broader economy.

“The economy has made considerable progress toward these objectives over the past year,” Powell said. He noted that inflation has “eased substantially” as “the risks to achieving our employment and inflation goals have been moving into better balance.”

Inflation as judged by the Fed’s preferred gauge is currently running at a 2.4% annual rate — 2.8% when stripping out food and energy in the core reading that the Fed prefers to focus on. The numbers reflect “a notable slowing from 2022 that was widespread across both goods and services prices.”

“Longer-term inflation expectations appear to have remained well anchored, as reflected by a broad range of surveys of households, businesses, and forecasters, as well as measures from financial markets,” he added.

Powell is likely to face a variety of questions during his two-day visit to Capitol Hill, which started with an appearance Wednesday before the House Financial Services Committee and concludes Thursday before the Senate Banking Committee.

Questioning largely centered around Powell’s views on inflation and rates.

Republicans on the committee also grilled Powell on the so-called Basel III Endgame revisions to bank capital requirements. Powell said he is part of a group on the Board of Governors that has “real concerns, very specific concerns” about the proposals and said the withdrawal of the plan “is a live option.” Some of the earlier market gains Wednesday faded following reports that New York Community Bank is looking to raise equity capital, raising fresh concerns about the state of midsize U.S. banks.

Though the Fed tries to stay out of politics, the presidential election year poses particular challenges.

Former President Donald Trump, the likely Republican nominee, was a fierce critic of Powell and his colleagues while in office. Some congressional Democrats, led by Sen. Elizabeth Warren of Massachusetts, have called on the Fed to reduce rates as pressure builds on lower-income families to make ends meet.

Rep. Ayanna Pressley, D-Mass., joined the Democrats in calling for lower rates. During his term, Democrats frequently criticized Trump for trying to cajole the Fed into cutting.

“Housing inflation and housing affordability [is] the No. 1 issue I’m hearing about from my constituents,” Pressley said. “Families in my district and throughout this country need relief now. I truly hope the Fed will listen to them and cut interest rates.”

Correction: Ayanna Pressley is a Democratic representative from Massachusetts. An earlier version misidentified the state.

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Fed officials expressed caution about lowering rates too quickly at last meeting, minutes show

WASHINGTON – Federal Reserve officials indicated at their last meeting that they were in no hurry to cut interest rates and expressed both optimism and caution on inflation, according to minutes from the session released Wednesday.

The discussion came as policymakers not only decided to leave their key overnight borrowing rate unchanged but also altered the post-meeting statement to indicate that no cuts would be coming until the rate-setting Federal Open Market Committee held “greater confidence” that inflation was receding.

“Most participants noted the risks of moving too quickly to ease the stance of policy and emphasized the importance of carefully assessing incoming data in judging whether inflation is moving down sustainably to 2 percent,” the minutes stated.

The meeting summary did indicate a general sense of optimism that the Fed’s policy moves had succeeded in lowering the rate of inflation, which in mid-2022 hit its highest level in more than 40 years.

However, officials noted that they wanted to see more before starting to ease policy, while saying that rate hikes are likely over.

“In discussing the policy outlook, participants judged that the policy rate was likely at its peak for this tightening cycle,” the minutes stated. But, “Participants generally noted that they did not expect it would be appropriate to reduce the target range for the federal funds rate until they had gained greater confidence that inflation was moving sustainably toward 2 percent.”

Before the meeting, a string of reports showed that inflation, while still elevated, was moving back toward the Fed’s 2% target. While the minutes assessed the “solid progress” being made, the committee viewed some of that progress as “idiosyncratic” and possibly due to factors that won’t last.

Consequently, members said they will “carefully assess” incoming data to judge where inflation is heading over the longer term. Officials noted both upside and downside risks and worried about lowering rates too quickly.

Questions over how quickly to move

“Participants highlighted the uncertainty associated with how long a restrictive monetary policy stance would need to be maintained,” the summary said.

Officials “remained concerned that elevated inflation continued to harm households, especially those with limited means to absorb higher prices,” the minutes said. “While the inflation data had indicated significant disinflation in the second half of last year, participants observed that they would be carefully assessing incoming data in judging whether inflation was moving down sustainably toward 2 percent.”

The minutes reflected an internal debate over how quickly the Fed will want to move considering the uncertainty about the outlook.

Since the Jan. 30-31 meeting, the cautionary approach has borne out as separate readings on consumer and producer prices showed inflation running hotter than expected and still well ahead of the Fed’s 2% 12-month target.

Multiple officials in recent weeks have indicated a patient approach toward loosening monetary policy. A stable economy, which grew at a 2.5% annualized pace in 2023, has encouraged FOMC members that the succession of 11 interest rate hikes implemented in 2022 and 2023 have not substantially hampered growth.

To the contrary, the U.S. labor market has continued to expand at a brisk pace, adding 353,000 nonfarm payroll positions in January. First-quarter economic data thus far is pointing to GDP growth of 2.9%, according to the Atlanta Fed.

Along with the discussion on rates, members also brought up the bond holdings on the Fed’s balance sheet. Since June 2022, the central bank has allowed more than $1.3 trillion in Treasurys and mortgage-backed securities to roll off rather than reinvesting proceeds as usual.

‘Ample level of reserves’

The minutes indicated that a more in-depth discussion will take place at the March meeting. Policymakers also indicated at the January meeting that they are likely to take a go-slow approach on a process nicknamed “quantitative tightening.” The pertinent question is how high reserve holdings will need to be to satisfy banks’ needs. The Fed characterizes the current level as “ample.”

“Some participants remarked that, given the uncertainty surrounding estimates of the ample level of reserves, slowing the pace of runoff could help smooth the transition to that level of reserves or could allow the Committee to continue balance sheet runoff for longer,” the minutes said. “In addition, a few participants noted that the process of balance sheet runoff could continue for some time even after the Committee begins to reduce the target range for the federal funds rate.”

Fed officials consider current policy to be restrictive, so the big question going forward will be how much it will need to be relaxed both to support growth and control inflation.

There is some concern that growth continues to be too fast.

The consumer price index rose 3.1% on a 12-month basis in January – 3.9% when excluding food and energy, the latter of which posted a big decline during the month. So-called sticky CPI, which weighs toward housing and other prices that don’t fluctuate as much, rose 4.6%, according to the Atlanta Fed. Producer prices increased 0.3% on a monthly basis, well above Wall Street expectations.

In an interview on CBS’ “60 Minutes” that aired just a few days after the FOMC meeting, Chair Jerome Powell said, “With the economy strong like that, we feel like we can approach the question of when to begin to reduce interest rates carefully.” He added that he is looking for “more evidence that inflation is moving sustainably down to 2%.”

Markets have since had to recalibrate their expectations for rate cuts.

Where traders in the fed funds futures market had been pricing in a near lock for a March cut, that has been pushed out to June. The expected level of cuts for the full year had been reduced to four from six. FOMC officials in December projected three.

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Fed holds rates steady, indicates it is not ready to start cutting

WASHINGTON — The Federal Reserve on Wednesday sent a tepid signal that it is done raising interest rates but made it clear that it is not ready to start cutting, with a March move lower increasingly unlikely.

In a substantially changed statement that concluded the central bank’s two-day meeting this week, the Federal Open Market Committee removed language that had indicated a willingness to keep raising interest rates until inflation had been brought under control and was on its way toward the Fed’s 2% inflation goal. 

However, it also said there are no plans yet to cut rates with inflation still running above the central bank’s target. The statement further provided limited guidance that it was done hiking, only outlining factors that will go into “adjustments” to policy.

“The Committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2 percent,” the statement said.

During Fed Chair Jerome Powell‘s news conference, he said policymakers are waiting to see additional data to verify that the trends are continuing. He also noted that a March rate cut is unlikely.

“I don’t think it’s likely that the committee will reach a level of confidence by the” March meeting, Powell said.

“We want to see more good data. It’s not that we’re looking for better data, we’re looking for a continuation of the good data we’ve been seeing,” he added.

Markets initially took the news in stride but slid following Powell’s comments casting doubt on a March cut. The Dow Jones Industrial Average surrendered more than 300 points in the session while Treasury yields plunged. Futures pricing also swung, with the market assigning about a 64% chance the Fed would stay put at its March 19-20 meeting, according to CME Group calculations.

While the committee’s statement did condense the factors that policymakers would consider when assessing policy, it did not explicitly rule out more increases. One notable change was removing as a consideration the lagged effects of monetary policy. Officials largely believe it takes at least 12 to 18 months for adjustments to take effect; the Fed last hiked in July 2023 after starting the tightening cycle in March 2022.

“In considering any adjustments to the target range for the federal funds rate, the Committee will carefully assess incoming data, the evolving outlook, and the balance of risks,” the statement said. That language replaced a bevy of factors including “the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments.”

‘Moving into better balance’

Those changes were part of an overhaul in which the Fed seeks to chart a course ahead, with inflation moving lower and economic growth proving resilient. The statement indicated that economic growth has been “solid” and noted the progress made on inflation.

“The Committee judges that the risks to achieving its employment and inflation goals are moving into better balance,” the FOMC missive said. “The economic outlook is uncertain, and the Committee remains highly attentive to inflation risks.”

Gone from the statement was a key clause that had referenced “the extent of any additional policy firming” that might come. Some Fed watchers had been looking for language to emphasize that additional rate hikes were unlikely, but the statement left the question at least somewhat open.

Going into the meeting, markets had expected the Fed could begin reducing its benchmark overnight borrowing rate as soon as March, with May also a possible launching point. Immediately after the decision, stocks fell to session lows.

Policymakers, though, have been more circumspect about their intentions, cautioning that they see no need to move quickly as they watch the data unfold. Committee members in December indicated a likelihood of three quarter-percentage point rate cuts this year, less ambitious than the six that futures markets are pricing, according to the CME Group.

More immediately, the committee, for the fourth consecutive time, unanimously voted not to raise the fed funds rate. The key rate is targeted in a range between 5.25%-5.5%, the highest in nearly 23 years.

The Fed has been riding a wave of decelerating inflation, a strong labor market and solid economic growth, giving it both leeway to start easing up on monetary policy and caution about growth that could reaccelerate and drive prices higher again. Along with 11 rate hikes, the Fed also has been allowing its bond holdings to roll off, a process that has shaved more than $1.2 trillion off the central bank balance sheet. The statement indicated that the balance sheet runoff will continue apace.

The ‘soft-landing’ narrative

Many economists now are adopting a soft-landing narrative where the Fed can bring inflation down without torpedoing economic growth.

Separate reports Wednesday indicated that the labor market is softening, but so are wages. Payrolls processing firm ADP reported that private companies added just 107,000 new workers in January, a number that was below market expectations but still indicative of an expanding labor market. Also, the Labor Department reported that the employment cost index, a gauge the Fed watches closely for signals of inflation coming through wages, increased just 0.9% in the fourth quarter, the smallest rise since the second quarter of 2021.

More broadly, inflation as measured through core personal consumption expenditures prices rose 2.9% in December from the prior year, the lowest since March 2021. On a six- and three-month basis, core PCE prices both ran at or below the Fed’s target.

In a separate matter, the Fed also announced it was altering its investment policy both for high-ranking officials and staff. The changes expand the scope of those covered to include anyone with access to “confidential FOMC information” and said some staff might be required to submit brokerage statements or other documents to verify the accuracy of disclosures.

The changes follow controversy over multiple Fed officials trading from private accounts at a time when the central bank was making major changes to policy in the early days of the Covid pandemic.

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Fed holds rates steady, upgrades assessment of economic growth

The Federal Reserve on Wednesday again held benchmark interest rates steady amid a backdrop of a growing economy and labor market and inflation that is still well above the central bank’s target.

In a widely expected move, the Fed’s rate-setting group unanimously agreed to hold the key federal funds rate in a target range between 5.25%-5.5%, where it has been since July. This was the second consecutive meeting that the Federal Open Market Committee chose to hold, following a string of 11 rate hikes, including four in 2023.

The decision included an upgrade to the committee’s general assessment of the economy. Stocks rallied on the news, with the Dow Jones Industrial Average gaining 212 points on the session.

“The process of getting inflation sustainably down to 2% has a long way to go,” Fed Chair Jerome Powell said in remarks at a news conference. He stressed that the central bank hasn’t made any decisions yet for its December meeting, saying that “The committee will always do what it thinks is appropriate at the time.”

Powell added that the FOMC is not considering or even discussing rate reductions at this time.

He also said the risks around the Fed doing too much or too little to fight inflation have become more balanced.

“This signals that while there is a potential risk for the Fed to do more, the bar has become higher for rate hikes, and we are clearly seeing this play out with two consecutive meetings of no policy action from the Fed,” said Charlie Ripley, senior investment strategist at Allianz Investment Management.

Economy has ‘moderated’

The post-meeting statement had indicated that “economic activity expanded at a strong pace in the third quarter,” compared with the September statement that said the economy had expanded at a “solid pace.” The statement also noted that employment gains “have moderated since earlier in the year but remain strong.”

Gross domestic product expanded at a 4.9% annualized rate in the third quarter, stronger than even elevated expectations. Nonfarm payrolls growth totaled 336,000 in September, well ahead of the Wall Street outlook.

There were few other changes to the statement, other than a notation that both financial and credit conditions had tightened. The addition of “financial” to the phrase followed a surge in Treasury yields that has caused concern on Wall Street. The statement continued to note that the committee is still “determining the extent of additional policy firming” that it may need to achieve its goals. “The Committee will continue to assess additional information and its implications for monetary policy,” the statement said.

Wednesday’s decision to stay put comes with inflation slowing from its rapid pace of 2022 and a labor market that has been surprisingly resilient despite all the interest rate hikes. The increases have been targeted at easing economic growth and bringing a supply and demand mismatch in the labor market back into balance. There were 1.5 available jobs for every available worker in September, according to Labor Department data released earlier Wednesday.

Core inflation is currently running at 3.7% on an annual basis, according to the latest personal consumption expenditures price index reading, which the Fed favors as an indicator for prices.

While that has decreased steadily this year, it is well above the Fed’s 2% annual target.

The post-meeting statement indicated that the Fed sees the economy holding strong despite the rate hikes, a position in itself that could prompt policymakers into a prolonged tightening stance.

In recent days, the “higher-for-longer” mantra has become a central theme for where the Fed is headed. While multiple officials have said they think rates can stay where they are as the Fed assesses the impact of the previous increases, virtually none have said they are considering cuts anytime soon. Market pricing indicates the first cut could come around June 2024, according to CME Group data.

Surging bond yields

The restrictive stance has been a factor in the surging bond yields. Treasury yields have risen to levels not seen since 2007, the earliest days of the financial crisis, as markets parse out what is ahead. Yields and prices move in opposite direction, so a rise in the former reflects waning investor appetite for Treasurys, generally considered the largest and most liquid market in the world.

The surge in yields is seen as a byproduct of multiple factors, including stronger-than-expected economic growth, stubbornly high inflation, a hawkish Fed and an elevated “term premium” for bond investors demanding higher yields in return for the risk of holding longer-duration fixed income.

There also are worries over Treasury issuance as the government looks to finance its massive debt load. The department this week said it will be auctioning off $776 billion of debt in the fourth quarter, starting with $112 billion across three auctions next week.

During a recent appearance in New York, Powell said he thinks the economy may have to slow further to bring down inflation. Most forecasters expect economic growth to tail off ahead.

A Treasury Department forecast released earlier this week indicated that the pace of growth likely will tumble to 0.7% in the fourth quarter and just 1% for the full year in 2024. Projections the Fed released in September put expected GDP growth at 1.5% in 2024.

In the wake of the Fed’s comments, the Atlanta Fed’s GDPNow growth tracker slashed expectations for fourth-quarter GDP almost in half to 1.2% from 2.3%. The gauge takes in data on a real-time basis and adjusts its estimates with the latest information.

Whitney Watson, co-CIO of fixed income and liquidity solutions at Goldman Sachs Asset Management, said it’s likely the Fed will keep its policy unchanged into next year.

“There are risks in both directions,” Watson said. “The rise in inflation expectations, owing to higher gas prices, combined with strong economic activity, preserves the prospect of another rate hike. Conversely, a more pronounced economic slowdown caused by the growing impact of higher interest rates might accelerate the timeline for transitioning to rate cuts.”

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Fed Chair Powell calls inflation ‘too high’ and warns that ‘we are prepared to raise rates further’

Federal Reserve Chair Jerome Powell on Friday called for more vigilance in the fight against inflation, warning that additional interest rate increases could be yet to come.

While acknowledging that progress has been made and saying the Fed will be careful in where it goes from here, the central bank leader said inflation is still above where policymakers feel comfortable. He noted that the Fed will remain flexible as it contemplates further moves, but gave little indication that it’s ready to start easing anytime soon.

“Although inflation has moved down from its peak — a welcome development — it remains too high,” Powell said in prepared remarks for his keynote address at the Kansas City Fed’s annual retreat in Jackson Hole, Wyoming. “We are prepared to raise rates further if appropriate, and intend to hold policy at a restrictive level until we are confident that inflation is moving sustainably down toward our objective.”

The speech resembled remarks Powell made last year at Jackson Hole, during which he warned that “some pain” was likely as the Fed continues its efforts to pull runaway inflation back down to its 2% goal.

But inflation was running well ahead of its current pace back then. Regardless, Powell indicated it’s too soon to declare victory, even with data this summer running largely in the Fed’s favor. June and July both saw easing in the pace of price increases, with core inflation up 0.2% for each month, according to the Bureau of Labor Statistics.

“The lower monthly readings for core inflation in June and July were welcome, but two months of good data are only the beginning of what it will take to build confidence that inflation is moving down sustainably toward our goal,” he said.

Powell acknowledged that risks are two-sided, with dangers of doing both too much and too little.

Powell's concerns about growth and the labor market being too strong are new, says Point72's Maki

“Doing too little could allow above-target inflation to become entrenched and ultimately require monetary policy to wring more persistent inflation from the economy at a high cost to employment,” he said. “Doing too much could also do unnecessary harm to the economy.”

“As is often the case, we are navigating by the stars under cloudy skies,” he added.

Markets were volatile after the speech, but stocks powered higher later in the day and Treasury yields were mostly up. In 2022, stocks plunged following Powell’s Jackson Hole speech.

“Was he hawkish? Yes. But given the jump in yields lately, he wasn’t as hawkish as some had feared,” said Ryan Detrick, chief market strategist at the Carson Group. “Remember, last year he took out the bazooka and was way more hawkish than anyone expected, which saw heavy selling into October. This time he hit it more down the middle, with no major changes in future hikes a welcome sign.”

A need to ‘proceed carefully’

Powell’s remarks follow a series of 11 interest rate hikes that have pushed the Fed’s key interest rate to a target range of 5.25%-5.5%, the highest level in more than 22 years. In addition, the Fed has reduced its balance sheet to its lowest level in more than two years, a process which was seen about $960 billion worth of bonds roll off since June 2022.

Markets of late have been pricing in little chance of another hike at the September meeting of the Federal Open Market Committee, but are pointing to about a 50-50 chance of a final increase at the November session. Projections released in June showed that almost all FOMC officials saw another hike likely this year.

Powell provided no clear indication of which way he sees the decision going.

“Given how far we have come, at upcoming meetings we are in a position to proceed carefully as we assess the incoming data and the evolving outlook and risks,” he said.

However, he gave no sign that he’s even considering a rate cut.

“At upcoming meetings, we will assess our progress based on the totality of the data and the evolving outlook and risks,” Powell said. “Based on this assessment, we will proceed carefully as we decide whether to tighten further or, instead, to hold the policy rate constant and await further data.”

The chair added that economic growth may have to slow before the Fed can change course.

Gross domestic product has increased steadily since the rate hikes began, and the third quarter of 2023 is tracking at a 5.9% growth pace, according to the Atlanta Fed. Employment also has stayed strong, with the jobless rate hovering around lows last seen in the late 1960s.

“The basic thought that they’re close to done, they think they probably have a little bit more to do … that is the story they’ve been telling for a little while. And that was the heart of what he said today,” said Bill English, a former Fed official and now a Yale finance professor.

“I don’t think this is about sending a signal. I think this is really where they think they are,” he added. “The economy has slowed some but not enough yet to make them confident inflation is going to come down.”

Indeed, Powell noted the risk of strong economic growth in the face of widespread recession expectations and how that could make the Fed hold rates higher for longer.

“It was a balanced but not trend-changing speech, even if the Fed kept the ‘mission accomplished’ banner in the closet,” said Jack McIntyre, portfolio manager at Brandywine Global. “It leaves the Fed with needed optionality to either tighten more or keep rates on hold.”

Getting into details

While last year’s speech was unusually brief, this time around Powell provided a little more detail into the factors that will go into policymaking.

Specifically, he broke inflation into three key metrics and said the Fed is most focused on core inflation, which excludes volatile food and energy prices. He also reiterated that the Fed most closely follows the personal consumption expenditures price index, a Commerce Department measure, rather than the Labor Department’s consumer price index.

The three “broad components” of which he spoke entail goods, housing services such as rental costs and nonhousing services. He noted progress on all three, but said nonhousing is the most difficult to gauge as it is the least sensitive to interest rate adjustments. That category includes such things as health care, food services and transportation.

“Twelve-month inflation in this sector has moved sideways since liftoff. Inflation measured over the past three and six months has declined, however, which is encouraging,” Powell said. “Given the size of this sector, some further progress here will be essential to restoring price stability.”

No change to inflation goal

In addition to the broader policy outlook, Powell honed in some areas that are key both to market and political considerations.

Some legislators, particularly on the Democratic side, have suggested the Fed raise its 2% inflation target, a move that would give it more policy flexibility and might deter further rate hikes. But Powell rejected that idea, as he has done in the past.

“Two percent is and will remain our inflation target,” he said.

That portion of the speech brought some criticism from Harvard economist Jason Furman.

“Jay Powell said all the right things about near-term monetary policy, continuing to hope for the best while planning for the worst. He was appropriately cautious on inflation progress & asymmetric about the policy stance,” Furman, who was chair of the Council of Economic Advisers under former President Barack Obama, posted on X, the social media site formerly known as Twitter. “But wish he had not ruled out shifting the target.”

On another issue, Powell chose largely to stay away from the debate over what is the longer-run, or natural, rate of interest that is neither restrictive nor stimulative – the “r-star” rate of which he spoke at Jackson Hole in 2018.

“We see the current stance of policy as restrictive, putting downward pressure on economic activity, hiring, and inflation,” he said. “But we cannot identify with certainty the neutral rate of interest, and thus there is always uncertainty about the precise level of monetary policy restraint.”

Powell also noted that the previous tightening moves likely haven’t made their way through the system yet, providing further caution for the future of policy.

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Fed raises key rate but hints it may pause amid bank turmoil

Federal Reserve Chairman Jerome Powell speaks during a news conference in Washington, Wednesday, May 3, 2023, following the Federal Open Market Committee meeting.
| Photo Credit: AP

The Federal Reserve reinforced its fight against high inflation Wednesday by raising its key interest rate by a quarter-point to the highest level in 16 years. But the Fed also signalled that it may now pause its streak of 10 rate hikes, which have made borrowing for consumers and businesses steadily more expensive.

In a statement after its latest policy meeting, the Fed removed a sentence from its previous statement that had said “some additional” rate hikes might be needed. It replaced it with language that said it will consider a range of factors in “determining the extent” to which future hikes might be needed.

Speaking at a news conference, Chair Jerome Powell said the Fed has yet to decide whether to suspend its rate hikes. But he pointed to the change in the statement’s language as confirming at least that possibility. Powell said the Fed would continue to monitor the latest economic data in deciding whether to pause its hikes.

Also read | Treasury’s Yellen says U.S. could hit debt ceiling as soon as June 1

The Fed’s rate increases since March 2022 have more than doubled mortgage rates, elevated the costs of auto loans, credit card borrowing and business loans and heightened the risk of a recession. Home sales have plunged as a result. The Fed’s latest move, which raised its benchmark rate to roughly 5.1%, could further increase borrowing costs.

Still, the Fed’s statement Wednesday offered little indication that its string of rate hikes have made significant progress toward its goal of cooling the economy, the job market and inflation. Inflation has fallen from a peak of 9.1% in June to 5% in March but remains well above the Fed’s 2% target rate.

“Inflation pressures continue to run high, and the process of getting getting inflation back down to 2% has a long way to go,” Mr. Powell said.

The surge in rates has contributed to the collapse of three large banks and turmoil in the banking industry. All three failed banks had bought long-term bonds that paid low rates and then rapidly lost value as the Fed sent rates higher.

The banking upheaval might have played a role in the Fed’s decision Wednesday to consider a pause. Powell had said in March that a cutback in lending by banks, to shore up their finances, could act as the equivalent of a quarter-point rate hike in slowing the economy.

At his news conference, Mr. Powell said he believed conditions in the industry have improved since early March and that “the U.S. banking sector is sound and resilient.” At the same time, he acknowledged that “the strains that emerged in the banking sector in early March appear to be resulting in even tighter credit conditions for households and businesses.” Fed economists have estimated that tighter credit resulting from the bank failures will contribute to a “mild recession” later this year, thereby raising the pressure on the central bank to suspend its rate hikes.

The Fed is now also grappling with a standoff around the nation’s borrowing limit, which caps how much debt the government can issue. Congressional Republicans are demanding steep spending cuts as the price of agreeing to lift the nation’s borrowing cap.

The Fed’s decision Wednesday came against an increasingly cloudy backdrop. The economy appears to be cooling, with consumer spending flat in February and March, indicating that many shoppers have grown cautious in the face of higher prices and borrowing costs. Manufacturing, too, is weakening.

Even the surprisingly resilient job market, which has kept the unemployment rate near 50-year lows for months, is showing cracks. Hiring has decelerated, job postings have declined and fewer people are quitting jobs for other, typically higher-paying positions.

The turmoil in the nation’s banking sector, which re-erupted last weekend as regulators seized and sold off First Republic Bank, has intensified the pressure on the economy. It was the second-largest U.S. bank failure ever and the third major banking collapse in the past six weeks. Investors have grown anxious about whether other regional banks may suffer from similar problems.

Goldman Sachs estimates that a widespread pullback in bank lending could cut U.S. growth by 0.4 percentage point this year. That could be enough to cause a recession. In December, the Fed projected growth of just 0.5% in 2023.

Wall Street traders were also unnerved by this week’s announcement from Treasury Secretary Janet Yellen that the nation could default on its debt as soon as June 1 unless Congress agrees to lift the debt limit, which caps how much the government can borrow. A first-ever default on the U.S. debt could potentially lead to a global financial crisis.

The Fed’s rate hike Wednesday comes as other major central banks are also tightening credit. European Central Bank President Christine Lagarde is expected to announce another interest rate increase Thursday, after inflation figures released Tuesday showed that price increases ticked up last month.

Consumer prices rose 7% in the 20 countries that use the euro currency in April from a year earlier, up from a 6.9% year-over-year increase in March.

In the United States, some major drivers of higher prices have stalled or started to reverse, causing slowdowns in overall inflation. The consumer price index rose 5% in March from a year earlier, sharply lower than its 9.1% peak in June.

The rise in rental costs has eased as more newly built apartments have come online. Gas and energy prices have fallen steadily. Food costs are moderating. Supply chain snarls are no longer blocking trade, thereby lowering the cost for new and used cars, furniture and appliances.

Still, while overall inflation has cooled, “core” inflation — which excludes volatile food and energy costs — has remained chronically high. According to the Fed’s preferred measure, core prices rose 4.6% in March from a year earlier, scarcely better than the 4.7% it reached in July.

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The Fed is likely to hike rates by a quarter point but it must also reassure it can contain a banking crisis

The Federal Reserve is expected to raise interest rates Wednesday by a quarter point, but it also faces the tough task of reassuring markets it can stem a worse banking crisis.

Economists mostly expect the Fed will increase its fed funds target rate range to 4.75% to 5% on Wednesday afternoon, though some expect the central bank could pause its hiking due to concerns about the banking system. Futures markets were pricing in a roughly 80% chance for a rate rise, as of Tuesday morning.

The central bank is contemplating using its interest rate tools at the same time it is trying to soothe markets and stop further bank runs. The fear is that rising rates could put further pressure on banking institutions and crimp lending further, hurting small businesses and other borrowers.

“The broader macro data shows some further tightening is warranted,” said Michael Gapen, chief U.S. economist at Bank of America. He said the Fed will have to explain its double-barreled policy. “You have to show you can walk and chew gum at the same time, using your lender-of-last-resort powers to quell any fears about deposit flights at medium-sized banks.”

U.S. Federal Reserve Chair Jerome Powell addresses reporters after the Fed raised its target interest rate by a quarter of a percentage point, during a news conference at the Federal Reserve Building in Washington, February 1, 2023.

Jonathan Ernst | Reuters

Federal regulators stepped in to guarantee deposits at the failed Silicon Valley Bank and Signature Bank, and they provided more favorable loans to banks for a period of up to one year. The Fed joined with other global central banks Sunday to enhance liquidity through the standing dollar swap system, after UBS agreed to buy the embattled Credit Suisse.

Investors will be looking for assurances from Fed Chairman Jerome Powell that the central bank can contain the banking problems.

“We want to know it’s really about a few idiosyncratic institutions and not a more pervasive problem with respect to the regional bank model,” said Gapen. “In these moments, the market needs to know you feel you understand the problem and that you’re willing and capable of doing something about it. … I think they are exceptionally good at understanding where the pressure is that’s driving it and how to respond.”

A month of turmoil

Markets have been whipsawed in the last month, first by a hawkish-sounding Fed and then by fears of contagion in the banking system.

Fed officials begin their two-day meeting Tuesday. The event kicks off just two weeks after Powell warned a congressional committee that the Fed may have to hike rates even more than expected because of its battle with inflation.

Those comments sent interest rates soaring. A few days later, the sudden collapse of Silicon Valley Bank stunned markets, sending bond yields dramatically lower. Bond yields move opposite price. Expectations for Fed rate hikes also moved dramatically: What was expected to be a half-point hike two weeks ago is now up for debate at a quarter point or even zero.

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The 2-year Treasury yield is most sensitive to Fed policy.

Messaging is the key

Gapen expects Powell to explain that the Fed is fighting inflation through its rate hikes but then also assure markets that the central bank can use other tools to preserve financial stability.

“Things going forward will be done on a meeting-by-meeting basis. It will be data dependent,” Gapen said. “We’ll have to see how the economy evolves. … We’ll have to see how financial markets behave, how the economy responds.”

The Fed is scheduled to release its rate decision along with its new economic projections at 2 p.m. ET Wednesday. Powell will speak at 2:30 p.m. ET.

The issue is they can change their forecast up to Tuesday, but how does anyone know?

Diane Swonk

Chief economist at KPMG

Gapen expects the Fed’s forecasts could show it expects a higher terminal rate, or end point for rate hikes, than it did in December. He said it could rise to about a level of 5.4% for 2023, from an earlier projection of 5.1%.

Jimmy Chang, chief investment officer at Rockefeller Global Family Office, said he expects the Fed to raise interest rates by a quarter point to instill confidence, but then signal it is finished with rate hikes.

“I wouldn’t be surprised if we get a rally because historically whenever the Fed stops hiking, going to that pause mode, the initial knee-jerk reaction from the stock market is a rally,” he said.

He said the Fed will not likely say it is going to pause, but its messaging could be interpreted that way.

“Now, at the minimum, they want to maintain this air of stability or of confidence,” Chang said. “I don’t think they’ll do anything that could potentially roil the market. … Depending on their [projections], I think the market will think this is the final hike.”

Fed guidance could be up in the air

Diane Swonk, chief economist at KPMG, said she expects the Fed is likely to pause its rate hiking because of economic uncertainty, and the fact that the contraction in bank lending will be equivalent to a tightening of Fed policy.

She also does not expect any guidance on future hikes for now, and Powell could stress the Fed is watching developments and the economic data.

“I don’t think he can commit. I think he has to keep all options on the table and say we’ll do whatever is necessary to promote price stability and financial stability,” Swonk said. “We do have some sticky inflation. There are signs the economy is weakening.”

Fed needs to 'call a timeout' and stop hiking rates, says Bleakley's Peter Boockvar

She also expects it will be difficult for the Fed to present its quarterly economic forecasts, because the problems facing the banks have created so much uncertainty. As it did during the Covid pandemic in March 2020, the Fed might temporarily suspend projections, Swonk said.

“I think it’s an important thing to take into account that this is shifting the forecast in unknown ways. You don’t want to overpromise one way or the other,” she said. Swonk also expects the Fed to withhold its so-called dot plot, the chart on which it shows anonymous forecasts from Fed officials on the path for interest rates.

“The issue is they can change their forecast up to Tuesday, but how does anyone know? You want the Fed to look unified. You don’t want dissent,” said Swonk. “Literally, these dot plots could be changing by the day. Two weeks ago, we had a Fed chairman ready to go 50 basis points.”

The impact of tighter financial conditions

The tightening of financial conditions alone could have the clout of a 1.5 percentage point hike in rates by the Fed, and that could result in the central bank cutting rates later this year, depending on the economy, Swonk said. The futures market is currently forecasting much more aggressive rate cutting than economists are, with a full percentage point — or four quarter-point cuts — for this year alone.

“If they hike and say they will pause, the market might actually be okay with that. If they do nothing, maybe the market gets nervous that after two weeks of uncertainty the Fed’s backing off their inflation fight,” said Peter Boockvar, chief investment officer at Bleakley Financial Group. “Either way we still have a bumpy road ahead of us.”

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The Fed could also make a surprise move by stopping the runoff of securities from its balance sheet. As Treasurys and mortgages mature, the Fed no longer replaces them as it did during and after the pandemic to provide liquidity to financial markets. Gapen said changing the balance sheet runoff would be unexpected. During January and February, he said about $160 billion rolled off the balance sheet.

But the balance sheet recently increased again.

“The balance sheet went up by about $300 billion, but I think the good news there is most of that went to institutions that are already known,” he said.

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