La Française: Something broke, but it will probably not be enough to stop the hiking process

March 22, 2023

We expect that the Federal Open Market Committee (FOMC) to hike rates by a second-consecutive 25 basis points (bps) at its March meeting.

The Federal reserve will keep unchanged its new Summary of Economic Projections (SEP) compared with the December SEP, and the dot plot will show a quarter of a percentage point of additional tightening in 2023 given the persistence of underlying inflation. We do not believe the board will stop reducing the size of its balance sheet despite financial risk.

Please find below what we expect:

• The FOMC to hike rates by another 25 bps to a range of 5.00%-5.25% to bring inflation down to its 2% target.
• Chair Powell will reaffirm that monetary policy is data dependent.
• Despite the failure of two U.S. regional banks and the risk of contagion in the banking industry (tighter financial conditions, credit supply, deposits flight), the Fed will continue its quantitative tightening at $95bn per month given their new backstop named Bank Term Funding Program (BTFP) to contain financial risks. The BTFP announced by the Fed on March 12 is an additional source of liquidity against high-quality securities marked at par, eliminating an institution's need to quickly sell those securities in times of stress.
• Mr. Powell will signal that the board is ready to adjust the rate and balance sheet path if conditions warrant.
• On the side of the dot plot, we expect to see the median dot up from 5.10% to 5.4% in 2023 and from 4.1% to 4.4% in 2024 but no change at 3.1% in 2025 with inflation declining.
• On the new economic projections, we expect minimal change in growth and inflation (Personal Consumption Expenditure, PCE) for 2023 (at 0,5% and 3,1%), 2024 (at 1,6% and 2,5%) and 2025 (at 1,8% and 2,1%).

As it was the case last week before the ECB meeting, the decision from the FED is highly uncertain. Our analysis is that the FED (like the ECB) is hoping that the mechanisms (BTFP, USD swap lines) put in place lately to contain risks will prove to be efficient.

As of now, if we exclude US regional banks and the AT1 market in Europe, financial markets do not show a high level of stress. With the still very high level of inflation and a very low unemployment rate, the Fed will in our opinion choose to proceed with a 25bps hike.