A dovish hike amidst a cloud of uncertainty: Risks to the downside

The Federal Open Market Committee (FOMC) - the Federal Reserve’s policy setting arm – voted to raise rates a quarter point to a 4.75%-5% range, in-line with market expectations. The vote was unanimous. The statement following the decision underscored inflation remains elevated but left guidance on future rate hikes ambiguous. The goal was to show confidence in the banking sector, while acknowledging that there was a high level of uncertainty about how much tightening is now in the pipeline. “Events in the banking system over the past two weeks are likely to result in tighter credit conditions for households and businesses.”

Powell acknowledged that the committee considered a pause. The decision to raise rates only 0.25% instead of 0.5% reflects the reality that conditions have changed. The band of uncertainty around how tight credit conditions will become in the weeks and months to come is high.  

Powell said that concerns about contagion to the broader banking system were the reason that Treasury, the Federal Reserve and the FDIC saw the events of the last two weeks as systemic. Powell acknowledged that any estimates of how much tightening the economy is likely to experience as a result of the tightening of credit conditions is a “guess.”

The summary of economic projections was published with today’s decision. The consensus was for one additional rate hike and holding thereafter. The Fed has slightly weaker growth and higher inflation for longer than it had in December, the date of the last official forecast. There was one outlier among the group, who saw rates rising to nearly 6% before the Fed is done. Powell downplayed the usefulness of the forecast, given the risks we now face.  

Powell’s tenor was significantly more tentative and less confident than he was in February. The crisis has clearly shaken him. He was careful to leave all policy options on the table. He was hesitant to formally guarantee all depositors are insured – there is no way for the Fed to currently do that - but said that depositors “should assume their deposits are safe.”

Powell did acknowledge that recessions are “nonlinear,” a word that is important to remember. Once unemployment starts rising, it is hard to tell how high it will rise. Powell said that financial conditions have tightened more than traditional measures would suggest.  

However, Powell attempted to shut the door on rate cuts this year by arguing that they are not in the base case scenario. The Fed is still fighting inflation, for now. “That is all I have to say,” Powell closed.