The March FOMC decision: Is the Fed done tightening?

In the statement, the Federal Reserve (Fed) acknowledged the potential implications of banking turmoil on the economic outlook but highlighted that at this point, it’s uncertain how big that impact will be.

In a highly anticipated policy decision, the Federal Open Market Committee (FOMC) voted unanimously to raise the Federal funds rate by 0.25% to a target range of 4.75%-5.00% at their March meeting.  In the statement, the Federal Reserve (Fed) acknowledged the potential implications of banking turmoil on the economic outlook but highlighted that at this point, it’s uncertain how big that impact will be. Importantly, the Fed still feels additional tightening may be needed, but they downshifted the phrase “ongoing increases in the target range...” to “some additional policy firming may be appropriate.” The statement did not include any changes to its balance sheet reduction plan.

The Summary of Economic Projections (SEP) and the median “dot” plot reflected a slightly more dovish picture of slower economic growth, a touch lower unemployment, slightly higher inflation and unchanged policy projections.

Highlights from the SEP and dot plot:

  • The median expectation for the federal funds rate was unchanged at 5.1% for year-end, suggesting an additional 25 basis point (bp) hike to come. Policymakers are also projecting less easing next year, suggesting policy is expected to be tighter for longer.
  • While the median expectation was unchanged for 2023, some policymakers are becoming more hawkish. One official now sees rates ending this year between 5.75-6.00%, up from zero in December, and three officials see rates ending between 5.50%-5.75%, compared with two officials in December.
  • Expectations for the year-over-year headline and core PCE deflator were nudged higher to 3.3% and 3.6% for 4Q23, respectively.
  • Expectations for growth were downgraded, likely reflecting an expected drag from tighter credit conditions in the coming quarters.

Before the banking crisis, several Fed members had argued that the fed funds projection for this year would need to be revised higher in light of recent inflation and activity data. Just two weeks ago, the Chair of the U.S. Fed, Jerome Powell, suggested the pace of rate hikes might have to increase to 0.50%. The last two weeks of banking sector turmoil convinced the Fed to take a milder approach, and Powell revealed that they considering pausing, but ultimately still felt that a hike was appropriate.

At the press conference, Powell emphasized the Fed’s data dependency and commented that credit tightening may, in effect, substitute for rate hikes. He remained firm on the committee’s resolve to bring inflation back down to 2% and pointed to the lack of progress in non-housing services inflation. He also pushed back against the notion of rate cuts this year, which markets are still pricing in.

To be clear, we don’t think the Fed should have hiked today and the central bank has done more than enough tightening to gradually return inflation to target. The banking system turmoil reveals a predictable vulnerability of an economy facing a whiplash of rates from very low levels for the best part of 15 years to now sharply higher levels, and there is likely more pain to come. Financial conditions have tightened meaningfully and lending standards will tighten further, contributing to a further slowdown in economic growth in the second half of year. For investors, this more tepid outlook emphasizes the need for bonds in portfolios to provide ballast, while positioning somewhat defensively within equities as growth concerns loom. 

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