Federal Reserve Hikes Key Rate, Signals It's Almost Done; S&P 500 Wavers

The stock market is reacting positively to the increasing likelihood of a recession, as investors expect the Fed to respond with lower interest rates.

Federal Reserve Hikes Key Rate, Signals It's Almost Done; S&P 500 Wavers

As the banking panic recedes, the Federal Reserve raised its key interest rate by 25%. This was to keep inflation under control. New Fed forecasts indicate that there will be only one more rate increase as continued concerns about the health of banks complicate the plan by policymakers to keep interest rates higher longer. After the Fed's policy statement was released, the S&P 500 rose slightly but then turned slightly negative when Chair Jerome Powell spoke about the outlook.

Federal Reserve Meeting Highlights

Wednesday's rate increase raised the federal funds target range from 4.75% to 5%.

Federal Reserve policy committee members have released new quarterly projections that show they expect the Fed's key rate to be 5.1% by 2023. This would imply one more rate hike.

The Fed sees the benchmark federal funds rates falling to 4.3% by 2024, which is higher than the 4.1% forecasted in December.

Since March 2022, every Fed meeting has indicated that there was a possibility of "ongoing rises" in the policy rates. Wednesday's statement, however, dropped this language and stated that the Fed believed that "some additional policy firming might be appropriate."

The bottom line: The Fed is almost done with hiking.

The Fed has lowered the outlook for economic growth from 0.5% in December projections to 0.4%. The Fed now expects that GDP will grow by 1.2% in 2024. This is down from 1.6% in December’s projections. The Fed sees the unemployment rate rising to 4.5% by 2023, and 4.6% in 2024, compared to 3.6% at the moment.

Fed Chair Powell's News Conference

Jerome Powell, Fed chair, declared that all deposits in U.S. banks are "safe" following decisive actions by Treasury, FDIC and Treasury.

Powell stated that subdued growth was to be expected and that the risks to growth were "weighted towards the downside." Powell believes there is still a chance of avoiding recession. However, tightening bank credit could make it more difficult.

This is a significant change in tone. Powell and other Federal Reserve officials have stressed that inflation could become entrenched if there is not enough hiking.

Powell stated on February 1 that if inflation is prolonged, it will be "very difficult to manage." However, if Fed tightening makes the economy worse than it needs to, Powell said that "we have tools that could work on that."

Powell stated that the Fed would closely monitor credit conditions in order to determine the best path forward for interest rate hikes. He said that there was "strong consensus" to raise rates due to evidence of strong job growth, and the possibility of inflation starting in the new year.

Powell anticipates that there will be a tightening in financial conditions due to the recent bank turmoil. This will affect households and businesses as they seek credit.

Powell stated that "Monetary policies might have less work to complete" because credit tightening is similar to a rate rise.

Markets bet on Fed Rate Drops

Markets are still betting on Powell's comments and Wednesday's Federal Reserve meeting policy announcement. They also expect that policymakers will switch from increasing rates to cutting them this fall. According to market pricing, the federal funds target rate for the year ending in December will be below 4.5%

This is a marked change from March 7, when Powell’s hawkish testimony to the Senate led markets to price in a half point hike at the Fed meeting this week. Markets expected that the Fed's key interest rate would rise to 5.5%-5.5% by September. Two days later, SVB Financial Group began a downward spiral which quickly spread to large parts of the U.S. bank sector.

PacWest Bancorp (PACW), which stated Wednesday that its deposits had stabilized in the recent days but not before falling 20% during panic caused by SVB's bankruptcy, said it. Wednesday saw a sharp drop in PACW stock.

S&P 500 Reaction

After initially rising on Powell's news conference and the Fed decision, Wednesday's volatility in stock market action saw the S&P 500 slip 0.1%. After Monday's 0.9% gain, which saw the index return to its 200-day moving mean, the S&P 500 climbed 1.3% Tuesday ahead of the Fed meeting.

After the Fed policy announcement, the 10-year Treasury yield dropped 11 basis points to 3.5%. Although the 10-year Treasury yield has rebounded from its lows during bank crisis, it is still below its close to 4% level prior to SVB's collapse.

The 2-year Treasury yield fell 20 basis points to 3.988%, which is closer to the near-term Fed Rate outlook.

Investors are weighing the outcomes of the Fed meeting as well as whether the banking crisis might be good for stocks.

"Arguably it would be better to the broader stock markets if growth slowed down because banks become more conservative with their lending than if the Fed raised rates to over 6 percent," BCA Research strategists, Peter Berezin, wrote March 16.

BCA stated that the economy would slow in both cases. BCA wrote that in a bank-led slowdown, the "deflate rate applied to earnings would be lower," which would benefit stock valuations. Analysts acknowledge that growth could slow down or even collapse. If the Fed's policy is too restrictive, credit will become more difficult to obtain.

The S&P 500 rose 11.9% since Oct. 12's bear-market close low, but remained at 16.55% from January 2022's record closing high.

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