The Federal Reserve raised its benchmark interest rate by a quarter of a percentage point on May 3rd, its tenth consecutive increase in just over a year, but signalled it could soon pause its aggressive monetary tightening campaign. The Federal Open Market Committee’s latest increase, which had unanimous support from policymakers, brings the federal funds rate to a new target range of 5 per cent to 5.25 per cent, the highest level since mid-2007.
In a statement released after its two-day gathering, the central bank scrapped guidance it provided in March, when it said “some additional policy firming may be appropriate” to bring inflation under control. The FOMC on Wednesday said it would take into account its rate rises so far — and the fact they would take time to feed through to the economy — when “determining the extent to which” further increases “may be appropriate”.
It also said it would be guided by future economic data. In a press conference following the decision, Fed chair Jay Powell described the change of language as “meaningful”. He warned the recent banking turmoil appeared to be “resulting in even tighter credit conditions for households and businesses”, which was likely to weigh on economic activity and the labour market.
The yield on the two-year Treasury note, which moves with interest rate expectations, fell to its lowest level in a month as investors bet that this may be the Fed’s last increase of the current cycle. The yield was down 0.11 percentage points to 3.86 per cent.
The meeting came at a fraught moment for the US economy and financial system as midsized lenders continue to be clobbered after a series of bank failures. First Republic on May 1st became the third bank to be seized by US regulators in the past two months, with the Federal Deposit Insurance Corporation brokering a hasty takeover by JPMorgan. That followed emergency measures that government authorities took in March, just days before the last Fed meeting, to stem contagion after the implosion of Silicon Valley Bank and Signature Bank.
Officials must try to balance a potential credit contraction stemming from the banking turmoil against the fact that inflation remains stubbornly high and price pressures are moderating only gradually. Fed Chairman Powell said: “In principle, we won’t have to raise rates quite as high as we would have had this [banking turmoil] not happened.”
Policy is tight. There is also a psychological layer to it — that is a recognition that the more the Fed hikes rates, the more things could break (in the UD /global banking system.”
The European Central Bank also raised interest rates by a quarter of a point this week, warning that the fight against inflation is not over.
Global equities are have performed well over the past several months as investors believe that (unlike the ECB) inflation is being tamed but most markets are well below recent highs causing by the mini-banking crisis we have witnessed over the past 5 or 6 weeks which seems contained.
In this tentative environment bond yields are well below highs of a few months ago. The US 10-year bond yield is at 3.78% compared to recent 4.25% + 2023 highs.
The markets are looking for inflation to be tame further, a possible peak in Fed Funds /Interest Rates right now and hopes that no more banking difficulties surface.