The FOMC will announce its interest rate decision and offer an updated set of forecasts at 2pm EST today, Fed Chairman Powell will then hold a press conference at 2:30pm EST. The prospect of the Fed hiking rates again, while we have essentially witnessed four large bank failures in the last two weeks, is surreal in and of itself. But then again, we live in surreal times and nothing should surprise anyone at this point.
The Fed finds itself in a very difficult spot. On the one hand recent Fed speaker rhetoric has been one of "higher for longer", "there is more to be done in the inflation fight", and "prepared to increase the pace of rate hikes".
Remember, that it was only two weeks ago that markets were pricing in another 100bps of rate hikes in 2023:
However, in the last two weeks the global banking system has experienced a heart attack of sorts. One of the most globally important banks of the last several decades, Credit Suisse, f̶a̶i̶l̶e̶d̶ .....err... was acquired by UBS with hefty government guarantees to sweeten the deal.
Meanwhile, the US has a big problem on its hands in the form of uninsured deposits at regional banks that are too small to be considered "systemic risks" - this has led to massive deposit flight to large money center banks and money market funds (areas of the banking system that would be considered systemically critical).
$100 billion fled to money market funds last week, bringing the total to more than $400 billion since the Fed began hiking rates last year.
To be clear, I do not see a strong move for the Fed today. I believe they are stuck trying to find the path of least regret, knowing that something has to be sacrificed. The market is currently pricing in about a 4 in 5 chance of a 25bps rate hike, while also laying slightly less than even money that this will be the final rate hike from the Fed in this cycle.
Barring a surprise rate cut (Nomura sees a 25bps rate cut from the Fed this afternoon), I see two main possibilities for this FOMC meeting plays out:
- Fed Pauses: market reaction = "uh oh, things are actually really bad.... and inflation might keep running hot....."
- Fed hikes 25bps: market reaction = "Financial conditions have tightened massively in recent months, and they are getting even tighter...."
I don't think the Fed has a good move, but the 'dovish hike' is probably the path of least regret: A rate hike to make themselves not look like complete fools (based upon speeches and rhetoric of 2-3 weeks ago), while Powell will also spend a lot of time acknowledging that downside risks have risen is probably the way to go. The tone of the press conference will be crucial in instilling confidence, and Powell's every syllable will be carefully parsed.
While I believe there is substantial risk of a 'sell on the news' post-FOMC (whatever the news is), I do foresee a large blanket guarantee of US deposits as likely to be announced in the next few weeks. The anticipation of this news is probably what has, at least partially (Fed swap lines also help), stemmed some of the bleeding in equities, and curbed the rallies in gold and Treasuries.
After surging above $2,000/oz early Monday morning, gold futures have pulled back to a level of support near $1940
However, with what will essentially be a government guarantee of trillions of dollars worth of deposits, will come an ever powerful State, and a 'financial whirlpool' that will be d̶i̶f̶f̶i̶c̶u̶l̶t̶ ....impossible to reverse, without taking everything down with it.
"There is, of course, another escape, but it risks a fall into a financial whirlpool. The government can print money for the banks to lend without going to the trouble of borrowing it from someone else. That has a name of its own: inflation. As the postwar era demonstrates, it is a whirlpool that is also difficult to reverse." ~ Lawrence Malkin, 1987
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