Institution Views: Comprehensive Review of March FOMC Meeting

Fed announced to increase 25 bps after March FOMC meetin. Before we talk about the comments of the intitutions, let's look at the basic facts.

I. Basic facts

1. The Fed raised rates by 25 basis points as expected by the market, and its Fed Fund rate expectation (dot plot) is a bit more hawkish compared with the December FOMC last year:

the median benchmark rate expectation is 5.1% at the end of 2023, the same as the December FOMC;

the median benchmark rate expectation is 4.3% at the end of 2024, higher than the December FOMC's 4.1%.

Source: Bloomberg

However, the market clearly does not agree with Fed's hawkish stance. Both Fed rate futures and the OIS are pricing in the Fed cutting rates to around 4% by the end of this year.

Source: Bloomberg

2. In the Summary of economic projections (SEP) given at the March FOMC meeting, Fed raised its inflation expectations for the end of this year and lowered its GDP and unemployment rate expectations

Source: Federal Reserve

3. Compared with the December FOMC post-meeting statement, March FOMC post-meeting statement mainly changes:

a. Job gains description changes from "have been robust" to "picked up in recent months, and are running at a robust pace"

b. Delete the phrase "Inflation has eased somewhat" and retain "Inflation remains elevated;

c. Delete the description of Russia's war against Ukraine;

d. Add the description of the U.S. banking system

"The U.S. banking system is sound and resilient. Recent developments are likely to result in tighter credit conditions for households and The extent of these effectsis uncertain. The Committee remains highly attentive to inflation risks."

e. Delete "on going increases in the target range will be appropriate" and replace it with "some additional policy firming may be appropriate".

This point implies that this rate hike may be the last of the current cycle, although the median dot plot given by the Fed shows that there will be another rate hike this year.

4. Key points of Powell's speech at the press conference

a. Fed, in cooperation with the Treasury and FDIC, established the BTFP (Bank Term Funding Program) to ensure the banks' liquidity, and gurantee deposits and the safety of the banking system;

b. Fed is strongly committed to bringing inflation back to its 2% target. Recent inflation data show that inflationary pressures remain high, thus raising inflation expectations; recent job market data, on the other hand, show that the job market remains quarterly compact, with labor demand far outstripping supply. But the Fed believes that the job market will gradually achieve a balance between supply and demand, easing upward pressure on wages, thus lowering the unemployment rate forecast slightly for the end of this year;

c. U.S. economic growth has slowed sharply since last year. Although the climate causes the consumption data in Q1 to lift, the high interest rate environment on the one hand makes the real estate market downturn, on the other hand, also limits the expansion of business fixed investment. Considered together, Fed lowered its forecast for U.S. real GDP growth this year and next year.

II. Institution Views

1. Goldman Sachs Jan Hatzius team report Tighter Credit Can Substitute for Rate Hikes (Mericle) argues that

a. The FOMC raised the funds rate by 25bp to 4.75-5% in March 2023, but projected a weak economic outlook for the rest of 2023 and a more cautious path for the funds rate than Chair Powell had indicated before the recent banking turmoil.

b. The FOMC and Goldman Sachs expect tighter credit conditions due to stress on small and midsize banks to weigh on economic activity and substitute for one or more rate hikes.

c. Goldman Sachs has a stronger economic forecast than the FOMC and expects two more 25bp rate hikes in May and June, while market expectations for the funds rate declined sharply after the FOMC meeting.

Fed fund rate path scenario assumptions and changes by Goldman Sachs

2. Wells Fargo and Credit Agricole both believe that the deletion of "on going increases in the target range will be appropriate” and addition of "some additional policy firming may be appropriate" in the Fed's post-meeting statement is a sign of dovishness, suggesting that the current rate hike cycle is coming to an end.

Both banks believe that the Fed will raise rates for the last time in May, but will not cut rates during the year. Societe Generale's report is even more positive that the Fed is dovish this time. The one more rate hike left on dot plot is uncertain under the background of unclear bank crisis.

The Fed's current rate hike is to stabilize inflation expectations, as inflation will likely only slip to 3%-4% before unemployment rises significantly, failing to reach the 2% target.

3. The report Rate hike is close to end, future towards "stagflation" by CICC's Liu Zhengning team points out that the Fed believes that the stronger-than-expected economic data and the recent bank crisis roughly "offset each other".

So Fed neither needs to raise rates too much, nor needs to cut rates soon, it is best to wait and see.

Liu Zhengning's team believes that the banking storm is a demand shock, which will have a dampening effect on economic growth and inflation. But given that the U.S. also faces many supply constraints, this will reduce the impact of demand shocks on inflation, the final result is more likely to be "stagflation" pattern.

4. The report of "Expectation trap and Last Straw" - March FOMC review" China Merchants Macro Zhang Jingjing team thinks that

a. The current high risks in the European and American banking industry will likely become the "last straw" for economic recession, and the absence of a liquidity crisis was the prerequisite for the further interest rate hikes by central banks in the past week. However, the interest rate hike will inevitably tighten credit conditions and accelerate economic recession. The U.S. stock market will continue to decline, and a decline in corporate performance is inevitable.

b. The annual outlook remains unchanged: the Federal Reserve will stop raising interest rates in the spring, turn dovish in Q2, and cut interest rates by year-end.

c. The yuan exchange rate may appreciate again, which is good news for yuan-denominated assets. Currently, the "blind man touching the elephant" phase of the domestic economy is coming to an end, and the risk in the U.S. banking industry has greatly increased the likelihood of the Fed ending interest rate hikes in Q2 and the U.S. dollar index will likely continue its recent weakness.

If the yuan returns to the appreciation channel in April, the attractiveness of yuan-denominated assets will reappear, and the domestic stock and bond markets will also welcome incremental funds such as foreign investment.

III. Tiger Team’s Views

Although the current Fed has temporarily stabilized systemic risks in the banking system by providing liquidity to troubled banks, as we noted in our article "Market Review: Banking Run Affects Fed Shift, Investing With Caution," banks are facing insufficient returns on long-term investments and credit assets in a low interest rate environment, and pressure to raise deposit rates in their liabilities.

Bank crisis won't end before Fed cuts rates

The loss of deposits across the entire US banking industry is not a problem unique to individual banks, nor did it occur only after the risk explosion in Silicon Valley banks, but has been ongoing for six months. Even with full guarantee support for deposits of more small and medium-sized banks by the Fed and the Treasury, or targeted credit support, this will only stabilize the situation temporarily.

Without a rate cut, Fed cannot fundamentally prevent deposit flows to places with potentially higher interest rates and similar risks, such as the current short-term US Treasury and money market funds.

However, although the current rate hike cycle of the Fed is already in its final stage, it still needs to give hawkish guidance to control inflation expectations and not undo the efforts made since last year.

Powell's answer about rate cuts

Therefore, when Powell was asked about the market's expectation that the Fed will cut interest rates at every meeting from now on, which obviously conflicts with your statement of maintaining high rates for a period of time, he said:

So we published an SEP today, as you will have seen, and it shows that basically participants expect relatively slow growth, a gradual rebalancing of supply and demand in the labor market, with inflation moving down gradually. In that most likely case, if that happens, participants don’t see rate cuts this year. They just don’t.

I would just say, as always, the path of the economy is uncertain and policy’s going to reflect what actually happens rather than what we write down in the SEP. But that’s not our baseline expectation.

we’re looking at what’s happening among the banks and asking, is there going to be some tightening in credit conditions, and then we’re thinking about that as effectively doing the same thing that rate hikes do.

So we’re looking—and we—it’s highly uncertain how long the situation will be sustained or how significant any of those effects would be, so we’re just going to have to watch.

In summary, although Powell did not admit it, he has actually given up on the "soft landing".

Recession and stagflation are both present, with $10-YR T-NOTE - main 2306(ZNmain)$ and $Gold - main 2304(GCmain)$ rising together, and US dollar with $SPDR S&P Regional Banking ETF(KRE)$ dropping together.

We believe that the Fed will ultimately pivot when inflation drops further to around 3%, and more fields of the economy are affected by the high interest rates.$NASDAQ(.IXIC)$ $S&P 500(.SPX)$ $DJIA(.DJI)$