Morning Report: The Fed hikes rates and pours cold water on rate hikes this year

Vital Statistics:

S&P futures3,99020.25
Oil (WTI)70.970.09
10 year government bond yield 3.48%
30 year fixed rate mortgage 6.48%

Stocks are rebounding this morning after yesterday’s Fed-induced sell-off. Bonds and MBS are up.

As expected, the FOMC hiked the Fed Funds target by 25 basis points yesterday. The Fed did discuss the recent turmoil in the banking sector, and they felt that this will restrict credit going forward. At the same time, the labor market has remained unusually tight and inflationary pressures have been stronger than expected. These two things more or less offset each other. The dot plot showed a minimal change in the forecast for the Fed Funds rate:

They also inched down their forecast for GDP growth and unemployment while taking up their forecast for inflation. So far, the Fed is not seeing any decrease in credit from the banking crisis, and therefore they didn’t feel the need to pause or cut rates. They did tweak the language about future rate hikes from “ongoing increases in the target range will be appropriate” to “some additional policy firming may be appropriate” to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2 percent over time.

On the banking system, the statement said: “The U.S. banking system is sound and resilient. Recent developments are likely to result in tighter credit conditions for households and businesses and to weigh on economic activity,
hiring, and inflation. The extent of these effects is uncertain. The Committee remains highly attentive to inflation risks”

Lots of market observers are calling for the Fed to pause due to the banking crisis, but the situation is so new that the Fed doesn’t have a read yet on the fallout. Any general restriction of credit will take some time to play out. Global central banks are more or less on the same page, with the ECB hiking 50 bp this week, and the Swiss National Bank hiking 50 this morning, despite the Credit Suisse situation.

The Fed Funds futures now don’t see rate cuts starting until September.

Janet Yellen, while testifying in front of the Senate was asked if the FDIC was considering doing a blanket guarantee of all deposits without Congressional authorization. The response was: “This is not something that we have looked at. It’s not something that we’re considering,” she said. “I have not considered or discussed anything having to do with blanket insurance or guarantees of all deposits.” It is an odd response given the question was specifically about Congressional authorization.

The punch line is that Treasury considers this an isolated case, and not indicative of future policy. Of course that is the only thing they could say. That said, I suspect this opens the door for full coverage of deposits, and FDIC insurance premiums will have to increase to cover the added risk. This will almost certainly exacerbate the situation with the small banks – the big ones can probably absorb the added cost more than the smaller ones who will have to pass on those costs via lower deposit rates. This will create a bank run in slow motion which resembles the disintermediation problem of the 1970s. It will almost certainly drive more consolidation in the banking sector and I wouldn’t be surprised to see a wave of bank mergers similar to the late 90s.

New home sales rose 1.1% MOM to a seasonally adjusted annual rate of 640,000 units. This is still down about 19% from last year. The median price rose slightly to $438k while the average price fell a touch to $499k. As Powell has emphasized, the housing market has been weak, which will start pulling down inflation by summer, but wages remain the driver.

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