U.S. Fed Hikes Rates Another 25 Bps, Signals Increases Are Near An End

The U.S. Federal Reserve delivers a 25-basis point rate increase. Greg Bonnell speaks with Hafiz Noordin, Portfolio Manager at TD Asset Management, about the Fed’s decision and the concerns surrounding the financial sector.

Transcript

Originally posted on March 22, 2023

Greg Bonnell: The US Federal Reserve has hiked interest rates by 25 basis points, a move that comes as policymakers also deal with the wave of banking turmoil. Hafiz Noordin, portfolio manager at TD Asset Management, joins us now with reaction. There’s a lot here to go through, Hafiz. I want to start with the big pressing issue. Heading into this meeting, a lot of discussion about financial stability concerns, but also, inflation hasn’t really gone anywhere. How did they balance that out today?

Hafiz Noordin: And yeah, exactly. That was the clear debate going into this. With all of the strain in the banking sector that we saw, could the Fed truly separate out its mandate around inflation, which is its primary mandate, but balancing against these clear risks in the banking sector? The market’s take going in was that, with all of the measures by the Fed, the FDIC, and the Treasury, in conjunction together, putting in new facilities to provide liquidity to the banking sector, the Fed could go ahead and proceed with a rate hike today of 25 basis points.

It was about 80% priced in, and that was what was delivered today was that rate hike acknowledging that inflation is still high. Core inflation’s still in that kind of 5 to 5.5 range. But what we did see from the statement today from the Fed was an acknowledgment that, yes, the US banking sector is strong, but there’s clearly going to be a net new tightening in credit conditions by banks to ensure that they’re shoring up their balance sheets, and that will affect the real economy, present more downside risk to growth, and provide more of a strength — this disinflationary trend that should go on for the next year or two.

Greg Bonnell: And that really was the shift that we’ve just seen in the past couple of weeks. Because two weeks ago, I think almost to the day, we were getting very tough talk from Jerome Powell about the need for ongoing increases. Definitely, that was part of the former statement. We’ll see ongoing increases. Last time he spoke, said maybe even that terminal rate, that endpoint that is higher than we thought it was going to be, that has gone by the wayside now. Today’s statement replaces ongoing increases with maybe some additional policy for now. How do we read all that in terms of the path forward?

Hafiz Noordin: Yes, so the terminal rate was the one that really got repriced. Earlier this month, after the string of really strong data in the US around the labor market inflation, consumption, the terminal rate got repriced from about 5% to almost 6%. And that really reflected this idea that the Fed would potentially even have to do 50 basis points at this meeting. Obviously, a lot has happened since early March. And what we’ve seen now instead is the terminal rate has gotten repriced back to 5%, which means that this hike is pretty much the last one that the market is expecting. And even when you look at the dot plot by the Fed today, it affirmed this idea that the 5% area is where we’re basically going to be for the foreseeable future.

Now, the main tension between the market and the Fed is when rate cuts start. The market — with all of the crisis that’s started in the banking sector of the last couple of weeks, the market basically pulled forward rate cuts to start as soon as this June or July. The Fed, with its statement today and its statement of economic projections today, pushed back on that, expects a kind of flat policy rate for the rest of the year. But that’s what is now yet to resolve.

Greg Bonnell: I want to pick up when you said earlier about the fact that what we have seen in the banking sector means that a certain amount of the tightening, and this was fully acknowledged in the statement and in the press conference from Chair Powell, that although they said the US banking system is sound and resilient, you are going to see tighter credit conditions. And this will feed through the economy — almost that idea that this turmoil we’ve seen in the banks will start to do some of the work for them, that they perhaps would have had to have done with rate hikes, and maybe then they can ease off of it.

Hafiz Noordin: Absolutely. That was a key point in the statement, and that Chair Powell did affirm in the press conference, which is that transmission mechanism. Through the banking channel of the higher policy rates that we’ve seen over the past year, 400-plus basis points in the policy rate, we’re seeing those lagged effects now take hold in the economy. And as soon as you start to see something to break, that does cause credit conditions to tighten. That means that the real economy is going to be impacted and growth can come down. And I think Chair Powell even went further on to say in the press conference that they even considered a pause because of what happened. So we went from considering 50 basis points to them considering even a pause in just a matter of a few weeks.

And the market really latched on to that, clearly, today, where stocks and bonds have really been rallying against that news, knowing now that the Fed is very attentive to this idea that financial stability has to be maintained to provide an orderly reduction in inflation, not a shock that can really kill the economy.

Greg Bonnell: Today’s statement and decision taken with the turmoil of the past couple of weeks, and the US regional banks, what does it mean for the US buck? The US buck had such a run, such a dominance. Where does it go from here?

Hafiz Noordin: Well, the move today is definitely the US dollar down. The reason is that the big repricing in the bond market is — when you look at the two-year part of the curve, which really reflects, kind of, changes in the policy rate or expectations of the policy rate, over the next couple of years, is down about 20 basis points or so. And so when you have lower short-end yields in the US, relative to the rest of the world, that usually means the US dollar goes down. And that’s what we are seeing. The euro is up today.

And so I think, for the most part, this theme now of the Fed pausing and now having to be more data dependent with a bias more to rate cuts coming down the line, that would really mean that the US dollar really doesn’t have much of a catalyst to go higher, unless we start to see upside surprises in inflation or labor data which causes a reassessment of this terminal rate above 5%.

Greg Bonnell: A lot has changed in a short period of time. Really, I appreciate you breaking it all down for us, Hafiz.

Hafiz Noordin: Absolutely.

Greg Bonnell: Hafiz Noordin, portfolio manager at TD Asset Management.

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