What action did the Fed take in its March 2023 meeting? Was it in line with expectations?
The Federal Reserve increased the Fed Funds Rate by 25-basis points (bps) to 4.75-5 per cent in this meeting. The market expectation was a little mixed. Recent data releases suggested that US inflation could be heading upward. That had led to expectations for another 50-bps rate hike in this meeting.
But the turbulence in financial markets after the Silicon Valley Bank collapse changed the sentiment and toned down the expectation. So, broadly, the 25-bps rate hike was in line with expectations.
Is there any change in Fed’s stance due to the ongoing banking crisis in the US?
Yes, the Fed has become less hawkish in this meeting. Earlier this month, the Federal Reserve Chairman, Jerome Powell, had indicated that aggressive rate hikes would continue to bring inflation down to the targeted 2 per cent.
But the FOMC statement now states that while it will continue ‘restrictive monetary policy’ this will be dependent on incoming data on inflation, global and financial market conditions.
What impact is the tightening having on US GDP and inflation? What do the projections show?
The US economy could see a slowdown. Preliminary US GDP data for the fourth quarter of 2022 shows that the economy has grown by 2.7 per cent. This is much lower than the 3.2 per cent growth seen in the third quarter. The ongoing banking crisis in the US is likely to weigh more on economic growth. Powell in his press conference said the impact of recent developments on the economy is unclear at the moment. But, as seen from the projections, it seems the recent banking crisis is likely to have a more negative impact on the economy. The Fed had revised the economic growth projection sharply down to 1.2 per cent in 2024. Earlier, it had forecast that the US economy will grow 1.6 per cent next year. For 2023, growth has been revised slightly lower to 0.4 per cent from 0.5 per cent estimated earlier.
On the inflation front, Personal Consumption Expenditure (PCE), the Fed’s inflation gauge, is projected to increase by 3.3 per cent. This is up from 3.1 per cent estimated in December last year. Non-housing services inflation seems to be a concern for the Fed, as stated by Powell in his press conference.
Is there a likelihood of the rate hikes pausing in the future?
Yes. As seen from the projections, the median funds rate has been left unchanged at 5.1 per cent for 2023. This means, only one rate hike of 25-bps is possible. There are six more meetings left for the year. So, if the Fed increases rates by 25 bps in its next meeting on May 3, 2023, it will be a pause for the rest of the year. Or, the central bank could pause in the next one or two meetings, to see how the banking crisis is evolving and impacting the economy and then hike rates in the second half of this year. But this is assuming that the median funds rate projection stays unchanged at 5.1 per cent for 2023.
Will there be a rate cut this year?
A strict ‘no’ is the answer from Powell in his press conference amid the ongoing the banking crisis. Powell’s tone indicated that in the absence of the ongoing crisis, the central bank would still be inclined towards aggressive rate hikes. Powell said unless the ongoing crisis is going to have a serious impact on the economy rate cuts are not their base case.
What does the Fed action mean for US dollar?
Room only for just another 25 bps rate hike is a negative for the dollar. The greenback has seen a strong rally as the US Treasury yields surged when the interest rates were increased. Now, after Wednesday’s hike, Treasury yields have come down sharply as the rate cycle is nearing is peak. If yields fall further, then that could drag the US dollar lower going forward.
What implication does it have for rupee?
Weakness in the US dollar will be positive for the Indian rupee. The domestic currency has risen 0.6 per cent from 82.66 on Tuesday to 82.15 now, as an immediate reaction for the Fed meeting outcome. So, further weakness in the dollar can take the rupee well above 82 towards 81 in the short-term. But if the banking crisis in the US worsens, then the rupee could weaken on the back of high-risk aversion in the market, even if the dollar remains weak.
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