Pause? Fed Hikes, But Leaves Door Ajar for More

As expected, the Federal Open Market Committee (FOMC) raised the Fed funds rate by 25 basis points to a range of 5.0-5.25%, with unanimity. Heading into the announcement, the market was pricing in an 88% chance of a hike per the CME FedWatch Tool. The accompanying statement did suggest this might be the final rate hike in this cycle by omitting prior language that had signaled more hikes ahead.

Instead, the FOMC will take into account various factors "in determining the extent to which additional policy firming may be appropriate to return inflation to 2 percent over time, the Committee will take into account the cumulative tightening of monetary policy." As my colleague Kathy Jones, our Chief Fixed Income Strategist, put in a note, "the bar seems pretty high for additional rate hikes, where the previous statement said additional tightening was likely."

Pre-GFC rates…at long last

This move caps off the most aggressive tightening cycle in four decades and puts the Fed funds rate, at long last, back to the level it was before the global financial crisis (GFC). As a reminder, the fed funds rate was near zero early last year. With a look ahead: "Tighter credit conditions for households and businesses are likely to weigh on economic activity, hiring, and inflation. The extent of these effects remains uncertain. The committee remains highly attentive to inflation risks." In other words, they are trying to express optionality. That is undoubtedly, in part, driven by what has been a strength in the labor market. Of note was the change in the statement now describing job growth as "robust" rather than having "picked up."

The aggressiveness of this cycle, with the Fed fighting a four-decade high in inflation, has put increasing pressure on the banking system, with three of the four largest bank failures occurring just in the past couple of months (Washington Mutual maintains the top spot from the GFC era). The emergency funding facility the Fed put in place following the failure of Silicon Valley Bank in March initially eased some strains, but with the more recent (and larger) failure of First Republic, those strains have re-emerged. Trying to quell burgeoning concerns, the FOMC statement reiterated that "the U.S. banking system is sound and resilient."