M&G: The Fed's diplomatic interest rate hike

M&G: The Fed's diplomatic interest rate hike

23 maart 2023

Rente Fed
Rente (04) inflatie

Fed raises rates by 25bps up to 5%. Not a huge surprise as markets spent most of February re-pricing in a hawkish Fed given strong data prints and sticky inflation (especially in services), then have spent the last couple of weeks pricing in a pause or cuts given a potential banking liquidity crisis and a tightening of lending conditions.

So, diplomatically, the Fed has settled in the middle at 25bps. Had they gone to 0, it would have been a huge signal to markets that financial stability meant more than the inflation-crushing narrative they've been thumping out for the good part of a year, and would have signaled there were more worries bubbling under the surface in the banking sector.

This way, it has acknowledged that this is a sign tighter monetary policy is filtering through into the economy, but we still haven't done enough to crush inflation back to target. Also not surprising vs the ECB who went +50bps last week - the Fed is both further ahead in their hiking cycle (supposedly) and they had an extra week to process all the volatility that has hit credit markets in recent days. 

We've also had a clear shift from 'no/soft landing' to 'hard landing', which they may see as supportive of their mandate and so they didn't need to be as aggressive as markets were pricing in a month ago. Even before the banking jitters, I was firmly in the camp that the US needed a recession to bring inflation back down to 2%, given the strength of the labour market and the stickiness of inflation.

Whether the Fed directly causes that recession or not is a different question - monetary policy acts with a lag (and a stronger lag in the housing market with their 30 year fixed structure vs other economies with much shorter mortgage tenors), but tighter lending conditions going forward from the banks likely does some of the work for them. 

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