Fed Plots Narrower Tightening Path Forward but Bank Struggles Have Markets Focused on Rate Cuts

The Federal Reserve attempted to strike a balance between maintaining financial conditions and price stability yesterday, hiking rates by 25bps and projecting just one more hike going forward. However, the FOMC decision and Chairman Powell’s subsequent press conference failed to restore confidence in banking sector equities. Moreover, futures and bond markets remain unconvinced that the Fed will remain committed to any more tightening, despite what policymakers signal.

Related ETF: SPDR S&P Bank ETF (KBE), SPDR S&P Regional Banking ETF (KRE) 

Two weeks of speculation and anticipation led up to one of the most anticipated FOMC meetings in recent memory. In the end, Fed policymakers decided to continue on raising rates, increasing the benchmark fed funds rate by 25bps in an attempt to balance their price stability objectives with the containment of concerns swirling around the US banking system. Yesterday’s decision coincided with fed funds futures markets’ suggested outcome, but the outlook provided for the rest of the year by Powell and his FOMC colleagues differs significantly from what traders are now pricing.

Quotes from the CME imply that, not only is the Fed’s rate hiking finished, but they could be cutting rates by August. Despite Powell’s insistence that “participants don’t see rate cuts this year” in response to questions during the post-meeting press conference, a potential second cut is priced in by November. Powell noted that the FOMC no longer anticipates “ongoing rate increases will be appropriate to quell inflation”, shifting the language to propose “some additional policy firming may be appropriate”. Median expectations from the FOMC’s Dot Plot indicate one more hike is in the cards before the end of the year, unchanged from the central bank’s previous guidance issued in December, but a material decline from some of the suggested peak rates for 2023 earlier this month. In our most recent Viewpoint, released less than three weeks ago, traders were pricing a 5.5% terminal rate, illustrating just how quickly conditions can change in a tightening cycle as aggressive as this one.

Not only are futures traders signaling rate cut expectations, but bond traders as well. Despite a hiking of the Fed’s short-term rate, longer-term rates fell in the aftermath of Powell’s press conference, telegraphing the market’s assumption that growth and inflation are likely to…