Fundamental Analysis

Fed Minutes Showed Recent Banking Turmoil May Result in Lower

Fed Minutes Showed Recent Banking Turmoil May Result in Lower

The minutes of the March 21-22, 2023, Federal Open Market Committee (FOMC) meeting reaffirmed that price and financial stability are of paramount importance to the Fed.

Regarding the economy, Committee members noted that “recent indicators point to modest growth in spending and output. At the same time, however, participants noted that employment growth has picked up in recent months and is proceeding at a robust pace; the unemployment rate has remained low. Inflation remained elevated.”

Committee members noted that despite a sound and resilient banking system, “recent developments in the banking sector are likely to tighten credit conditions for households and businesses and weigh on economic activity, hiring, and inflation. “Participants noted, however, that the overall effect on economic activity is uncertain at this time.

Participants discussed concerns about contagion from developments in the banking sector, noting that “the main problems appear to have been limited to a small number of banks with poor risk management practices and that the banking system remains sound and resilient.”

The minutes indicate that several participants “considered whether it would be appropriate to maintain the target range at this meeting.” Ultimately, participants felt that a 25 basis point increase was appropriate in light of strong recent data and continued high inflation. Some participants said that without the recent banking turmoil, a 50 basis point hike would have been appropriate given the strong economic backdrop.

Regarding the future stance of monetary policy, Committee members anticipated that “some additional tightening of monetary policy may be appropriate to achieve a sufficiently restrictive policy stance to bring inflation back to 2 percent over time. “Future rate increases will depend on the extent to which credit and financial conditions affect economic activity.

Today’s minutes confirm that the Fed is nearing the end of its rate-hiking cycle. The disinflationary process has been slow to materialise, and the economy remains resilient under the pressure of higher interest rates. However, tighter credit conditions resulting from the recent banking turmoil are likely to affect economic activity and negate the need for additional monetary restraint. This is reflected in the volatility of the yield on 2-year U.S. Treasury securities, which has fallen 129 basis points since its peak in March and is currently 102 basis points lower.

Although the Fed has succeeded in containing the risk of contagion in the banking sector, financial markets have significantly downgraded their assessment of future interest rate developments since the banking turmoil. A possible credit crunch has also been reflected in recession fears, which have increased in recent weeks. We expect the Fed to raise rates by 25 basis points in May before retreating to the sidelines to monitor the impact of its actions on the economy.