Federal Open Market Committee Statement: May 2023
Market Views from the Global Fixed Income, Currency & Commodities (GFICC) group
U.S. Rates Team
In line with market expectations, the Federal Open Market Committee (FOMC) voted to raise the federal funds rate by 25 basis points (bps) to a target range of 5.00% – 5.25%. There were no dissents.
- Economic Assessment and Outlook
The economic assessment was brief. Growth is modest, inflation remains elevated, and the unemployment rate is low.
The reference to banks added in March was maintained but edited slightly. It stated that the banking system was “sound and resilient” but that tighter credit conditions would put downward pressure on growth and inflation.
- Current Policy and Forward Guidance
The Committee is guiding towards a view that policy may now be sufficiently restrictive by removing an explicit reference to attaining that stance through “some additional rate hikes”.
The “extent to which additional policy firming” is needed remains data dependent and will consider the lags in which policy impacts the economy.
Chair’s Press Conference:
Chair Powell offered insight into the thought process on hiking 25bps, as well as the path ahead.
Policy is currently tight, and the Fed is most likely on pause:
1. “You will notice in the statement for March we had a sentence that said the committee anticipates that some additional policy firming may be appropriate. That sentence is not in the statement anymore… So that's a meaningful change that we’re no longer saying that we anticipate.”
2. “We have raised 500 basis points…You have 2% real rates. That's meaningfully above what many people would assess as…the neutral rate. So policy is tight. And you see that in interest sensitive activities…and if you put the credit tightening on top of that and the QT that's ongoing, I think…we may not be far off. Possibly even at that level.”
3. “Looking ahead we will take a data dependent approach in determining additional policy affirming may be appropriate.”
Policy is causing credit conditions to deteriorate:
4. “The economy is likely to face further headwinds because of tight credit conditions. They had been tightening in the last year or so. But the strains that emerged in the banking sector in March, result in tighter conditions. These tighter credit conditions are likely to weigh on economic activity, hiring and inflation…[though] the extent of these effects remains uncertain.”
5. “The SLOOS report is broadly consistent with how you see it and what we are seeing from other sources…You see small and medium-sized banks are feeling that they need to tighten credit standards.”
The desire to hold rates high is predicated on sticky inflation:
6. “We on the committee have a view that inflation is going to come down not so quickly...And if that forecast is broadly right, it would not be appropriate to cut rates...If you have a different forecast and markets have been…from time-to-time pricing in quite rapid reductions in inflation, we would factor that in.”
- In 2022, high inflation and low unemployment caused the Fed to raise policy rates well into restrictive territory. Today, the risks to policy are more balanced as the cumulative and lagged impact of monetary policy slows the real economy, puts downward pressure on inflation, and tightens credit conditions.
- As we arrive at the end of the hiking cycle, the government bond market should continue to see demand from investors looking to lock in relatively high risk-free rates. The impact of restrictive monetary policy will continue to slow activity and push prices lower, eventually leading to the consideration of rate cuts later in the year. As a result, we expect the 10-year yield to move towards a 3.00% – 3.50% trading range by year end.