The Federal Open Market Committee (FOMC) Decision

The FOMC raised the benchmark Federal Funds Rate (FFR) by 25 bps to 4.75 – 5.00%, in line with our expectation. Despite fundamental situation concerning the global financial market after banking crisis in the US and Europe, inflation in the US remains well above the desired level which explains the rate hike outcome. We find the tone from the latest statement did not change much, as the FOMC has been very clear with their intention to keep the interest rates higher for longer to push inflation rate down. Furthermore, the Federal Reserve Chair also said that “…inflation remains too high and the labour market continues to be very tight,” indicating the FOMC’s mandate to keep price stability is not over. In a nutshell, key takeaways are as follows:

• The Job Market Remains Robust and Is in Tight Situation Hence Inflation Remains Elevated.
• Balance sheet reduction (or Quantitative Tightening) to continue as planned. For the record, the Fed had earlier guided asset reduction of USD 60 billon for US Treasury and USD35 billion for mortgage-back securities each month.

• Credit conditions in the economy is expected to tighten further which is likely to weigh on economic activity, hiring and inflation.

• In its policy statement, the Fed dropped the reference to “ongoing increases” and said that some additional policy firming may be appropriate.

FOMC Median Forecast Update: FFR for December 2023 Is Left Unchanged

The March 2023 median forecast for FFR is unchanged at 5.1% which we believe the present banking crisis is already reflected considering series of stronger-thanexpected economic data before this banking saga started. FFR projection for 2024 was revised higher to 4.3% (December 2022 projection: 4.1%). PCE inflation is expected to be at 3.3% in 2023 (December 2022 projection: 3.1%), and core PCE to be at 3.6% in 2023 (December 2022 projection: 3.5%). At the same time, GDP was also revised slightly lower to 0.4%.

Inflation Is Still Elevated

The increase of the FFR is mainly due to inflation that is still far above the desired level. The headline inflation stood at 6.0% in February 2023, (January 2023: 6.4%), and PCE and core PCE stood at 5.4% (December 2022: 5.3%) and 4.7% (December 2022: 4.6%) in January 2023, respectively. Furthermore, the risk on inflation has not subsided as unemployment rate continued to hover at its 54-year low of 3.4% as of February 2023. In addition, wage growth of 4.0% y/y over the same period is indicative of strength in spending which was clearly manifested via 4.0% y/y increase in retail sales in February 2023 and the job openings is still 0.5 – 1.0 times higher than the pre-pandemic levels.

The Current Banking Crisis: Post event risk mitigation plans implemented help to alleviate extreme market negative

Without any bail-out involved, all relevant authorities including in the Europe have taken the necessary steps to prevent the repeat of global financial crisis. Key measures undertaken are as follows:

• The Fed – Introduced the Bank Term Funding Program (BTFP) to offer a oneyear loan to any financial institutions that is having funding problem. Since the banking crisis started, the Fed balance sheet increased by around USD300 billion (as of 15 March 2023) to provide liquidity into the financial system. In relation to this, we have also seen the same reaction during previous crises in 2008 Global Financial Crisis and 2020 COVID-induced recession.

• The Federal Deposit Insurance Corporation (FDIC) - Insured depositors have full access to their funds.

• Swiss National Bank – Based on Federal Council’s Emergency Ordinance, both Credit Suisse and UBS can obtain liquidity assistance loan for up to CHF100 billion (around USD 109 billion) and the SNB can grant Credit Suisse liquidity assistance loan up to CHF100 billion backed by federal default guarantee.

Our View

Since the US banking crisis started, the 2-year US Treasury yield had fallen in excess of 100bps as concerns on the contagion effect would hit the economy. From interest rate probability perspective, market is now expecting the FFR to peak 5.00% based on WIRP projections as shown in Exhibit 5, very well below the Fed’s dot plot median forecast of 5.10%. We view this divergence as being the result of how market participants raise their concerns on balance sheet impact arising from steepest rate hike in more than three decades while the Fed is coming from the perspective of the need to restore price stability. On that note, we were expecting the FFR to peak at 5.25% - 5.50% with no rate cuts this year as the weighting was entirely skewed towards stubbornly high inflation then. Nonetheless, recent development concerning banking sector in the US and Europe is the new risk factor to the outlook. As such, we now view that the FFR will peak at 5.00% - 5.25% by 1H2023, implying one more 25 bps hike. Any rate cut view will be reassessed again once we see clear evidence of consistent decline in inflation and also, to what extent the present banking crisis would affect the real economy. Clearly, as shown in Exhibit 3, credit condition is already tight.

Source: AmInvest Research - 24 Mar 2023