Market Comment - March 22, 2023

Market Comment:

The FOMC hiked its policy rate 25bps to 4.75%-5.00%. While a hike or a pause was much debated ahead of the meeting, the result was not a surprise in that the probability of the 25bp rate hike was over 80% priced in.

In its statement, the FOMC acknowledged the pickup in employment data and the solid inflation readings: “Job gains have picked up in recent months and are running at a robust pace; the unemployment rate has remained low. Inflation remains elevated.” Both January and February US payrolls surprised to the upside. February core CPI came in at 5.5% y/y and January core PCE was at 4.7% y/y – well above the Fed’s 2% target. Fed Chair Powell continued to emphasize the Fed’s inflation fight in the press conference, saying, “Without price stability, the economy will not work for anyone.”

The decision was unanimous, which was somewhat surprising. However, one supposes, that now is the time the FOMC needs to show unity in order to avoid adding any further jitters to the banking sector.

The Summary of Economic Projections (“SEP”) continued to show a range of views on the projected fed funds rate path. While the median fed funds rate projection for 2023 remained unchanged at 5.1%, 2024 was revised up to 4.3% from 4.1% . The dot plot showed a dispersion in forecasts, especially for 2025. The range in the fed funds rate projection for that year was 2.4% to 5.6%. While this was unchanged from the December SEP, it does show strongly differing views among participants.

Powell emphasized that it was too soon to judge the amount of credit tightening that has resulted from the recent banking sector turmoil. He did say that credit tightening could be a substitute for rate hikes and that a significant number of FOMC participants thought there would be further tightening in credit conditions and that those participants reflected this in their forecasts. However, if further tightening of credit conditions doesn’t materialize, then the policy rate could be higher than those participants projected.

Importantly, the FOMC does not see rate cuts this year - that is not its base case. However, the market disagrees and has priced in rate cuts starting this year after the May FOMC meeting.

On an issue that was widely discussed this week, the Fed’s balance sheet expansion, Powell emphasized that the recent balance sheet rise was not monetary policy related. It provided liquidity to banks and did not lower rates at the longer end of the curve.

As Fed Chair Powell was speaking, Treasury Secretary Yellen also was speaking. Yellen said that a move to back all bank deposits with FDIC insurance “is not something that we have looked at.”

This statement seemed to be different from what she implied yesterday (Tuesday) when she spoke and suggested that the US was ready to protect depositors at small banks if required and that they might be eligible for the same type of deposit back up extended to depositors at SVB and Signature Bank (both FDIC insured and uninsured deposits were guaranteed).

It was likely these comments that weighed on US equities and US yields (see below) more-so than Powell’s press conference remarks, Importantly, in referring to SVB, both Powell and Yellen emphasized that its bank run took place at an unprecedented speed.

Market reaction:

Since pre the Fed announcement, the 2 year yield is down about 17bps to 3.97% and the 10 year yield is down about 5bps to 3.49%. Gold is higher, up about USD 27 to USD 1,965. The VIX is stable to slightly lower at 20.4. The USD (DXY Index) fell 0.8% to at 102.31. US equity indexes were a bit lower as well: SPX -0.1% Nasdaq -0.12% INDU -0.6% at the time of writing.

Given the unusually aggressive nature of this Fed tightening cycle, and the long and variable lags in monetary policy, it is likely that there will be more periods of risk aversion ahead. In addition, US inflation, for the time being, remains elevated and sticky. We think both of these factors will support precious metals and the diamond commodity ahead.

Chart: DIAMINDX performance during financial crises.
(Source: Bloomberg, DS)

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