Putting aside the obvious implications of the above – namely uncertainty and, in turn, volatility – it would be wise to also consider what this means for the March Federal Open Market Committee (FOMC) meeting.
The last two weeks have left markets in turmoil and investors uncertain about the future. To recap:
- The Chair of the U.S. Federal Reserve (Fed), Jerome Powell, testifying in front of Congress on March 7, hawkishly stated that interest rates were “likely to be higher” than previously anticipated; futures markets immediately priced in additional rate hikes.
- Just a few days later, a banking crisis seemingly emerged, with the collapse of Silicon Valley Bank, the 16th-largest bank in the United States and the second-largest bank failure in U.S. history; near-instantly the rhetoric around rates changed from hikes to cuts.
- Next came an employment report with mixed messages of continued job gains and a low unemployment rate, but moderating wage pressure – good news for inflation.
- Then, another bank failure – Signature Bank – and the implementation of backstops and credit facilities from federal authorities to prevent additional bank runs and shore up depositors.
- U.S. consumer price index (CPI) data followed, coming in generally in-line with expectations but showing persistence in the important “core services” component of inflation.
- Overseas, Credit Suisse then appeared to run into trouble, initially unable to secure funding from its largest shareholder to plug a hole in its balance sheet left by falling deposits. Shortly thereafter, the bank entered an agreement with the Swiss central bank for a large loan facility.
- Finally, the European Central Bank (ECB) hiked the target overnight rate 50 basis points (bps), in-line with expectations but surprising those that felt the combination of perceived weakness in the U.S. and European banking sectors would encourage a more modest move higher.
In other words, investors have a lot on their plates.
Putting aside the obvious implications of the above – namely uncertainty and, in turn, volatility – it would be wise to also consider what this means for the March Federal Open Market Committee (FOMC) meeting. Given the rapidly evolving situation, it seems like any policy move will be a day-of decision based on market volatility as much as economic data. Still, there are two things that markets can expect:
- Out of an abundance of caution, the Fed will likely deliver a significant policy messaging pivot aimed at calming market worries.
- The Fed hiking cycle will likely end sooner than previously expected and at a lower terminal rate.
The implications of such action should be welcomed by investors. First, greater clarity on the terminal rate should soothe equity markets, particularly those with growthier biases; second, it is possible that peak rates are behind us, suggesting duration should play a bigger role in bond portfolios; and third, narrowing rate differentials will likely push the U.S. dollar lower, a boon for both large cap U.S. companies doing business overseas and for U.S. investors investing in dollar-denominated international assets.
Ultimately, with so many moving parts, it would be unwise to declare that “the coast is clear.” Still, by focusing on what recent events mean for future interest rate policy, it is possible for investors to cut through the noise and focus on the big picture.