The Federal Reserve may be hiking, but Powell casts doubt; The S&P 500 rises

The Federal Reserve raised its key interest rate above 5%, but signaled that it may do so as the banking turmoil increases the risk of a recession in the United States. Still, Fed Chairman Jerome Powell said economic developments may require further tightening. As Powell spoke, the S&P 500 briefly turned negative, then rallied as investors wondered if the Fed’s long-awaited pivot had arrived.


Federal Reserve Meeting Policy Statement

The Fed abandoned language adopted at the May meeting indicating that “further policy tightening may be appropriate.” In its place, the new statement from the Fed’s meeting said policymakers “will closely monitor incoming information and assess the implications for monetary policy.”

The Fed has not ruled out further rate hikes or explicitly announced a pause. However, simply stating that he is no longer leaning towards further rate hikes could be interpreted as an intention to remain on his guard, barring a big inflationary surprise.

The combination of today’s quarter-point rate hike and the removal of the tightening bias adds up to what economists call a “dovish rise.”

Still, Powell’s message was not particularly accommodating. He clarified that the choice is to maintain the Fed’s key rate as it is or to raise it further. In other words, rate cuts are not around the corner.

Ahead of today’s Fed meeting, Nomura economists Aichi Amemiya and Jacob Meyer wrote that they expected Powell to make it clear that near-term rate cuts are unlikely, “pushing against the current market price of a few rate cuts by the end of this year.”

The banking crisis is holding the Fed back

Were it not for the banking crisis, the Fed would likely be planning one or two more rate hikes. After Powell’s hawkish Senate testimony on March 7, markets were betting that the Fed’s key rate would hit a range of 5.5% to 5.75%.

But Powell said after the March 22 Fed meeting that a credit crunch stemming from the banking crisis would essentially replace rate hikes, leaving monetary policy with “less work to do.”

At the time, Powell said it was a guess as to how much the banking crisis would slow the economy. The latest batch of economic data still shows that inflation is far too high for the Fed and the labor market is still far too tight.

Tuesday’s Labor Department JOLTS report showed job openings fell by 384,000 to 9.6 million in March. Although this is a 15% drop since December, there are still 3.8 million more job vacancies than unemployed. Payroll processor ADP estimated on Wednesday that the economy added a surprisingly strong 296,000 private sector jobs in April.

Powell noted that the labor market remains “very tight.”

Bank stocks tumble

Still, if Fed policymakers were still open to further tightening, that view may have faded on Tuesday. Shares of regional banks took a beating as officials kicked off the Fed’s two-day meeting.

On Monday afternoon, markets were still pricing nearly a 30% chance that the Federal Reserve would hike today and then again on June 14. For JPMorgan Chase (JPM) would help stabilize the markets. PacWest Bancorp (PACW) plunged 27.8% and Western Alliance Bancorp (WALL) 15.1%. Even the regional super banks have been crushed, with Comedy (CMA) down 12.4% and Key Corp (KEY) 9.4%.

By Tuesday afternoon, nearly 30% chance of June rate hike dropped to zero.

The Fed is partly to blame, having let inflation escape and then resorted to rapid rate hikes to contain it. Banks now have many low interest loans on their books, as well as distressed commercial real estate loans. Yet banks have to fight to keep their deposits by offering high interest rates on savings accounts that can compete with money market interest rates around 5%.

S&P 500 reaction to Fed meeting

Shortly after the Fed meeting was declared, the S&P 500 rose 0.15% on Wednesday Action on the stock exchange, lower than it was before the 2 p.m. announcement. On Monday, the S&P 500 hit the February 2 high at 4195 before reversing lower. A pause signal from the Fed was widely priced in. However, it could set the S&P 500 up for another attempt to breach the top of its trading range since late August.

Be sure to read the IBDs The big picture every day to stay in tune with the direction of the market and what it means for your trading decisions.


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