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Friday, March 24, 2023

Late Fed Hike Comments

The Fed hiked the policy rate by 25 basis points this week, while forecasters were split on the outcome. My feeling is that this is a “dovish hike” — whatever that means. Realistically, the Fed wants to drift into at least a temporary pause while they survey the wreckage left behind by their hiking campaign.

One messaging problem facing the Fed is that any pause is going to be interpreted as a sign of panic about the banking system among the financial chattering class, particularly if inflation prints remain elevated. Their previous inflation forecast misses make it hard for them to sell a pause based on activity data.

The problem facing bond bulls is that bond yields are uncomfortably low relative to Fed Funds (figure above) in the absence of a clear recession signal. Activity data in the real economy is somewhat choppy, but my non-rigorous scanning of it is that the real economy is not yet seeing major problems. The news flow is pointing towards a banking system scare, which would hit the real economy more rapidly than slowing demand by itself.

Right now, the problems in the U.S. banking system appear to revolve around a handful of banks, none of them in the “global systemically important banks” category. The messaging from U.S. policymakers about deposit insurance has been somewhat amateurish, which is not helping. It is hard to get too excited about problems in banks that can be recapitalised quite easily, or even absorbed by larger banks. There are “systemic” worries about commercial real estate, which is a large enough borrowing sector to cause financial chaos if loans are impaired. That said, impairment of commercial real estate is going to be slow process.

Instead, there still seem to be ripple effects in European banks from the takedown of Credit Suisse. Given the size of the major European banks, problems there would have large knock-on effects to the developed economies. The only insight I can offer about European banks is that one needs access to reliable credit/banking analysis at times like this.

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(c) Brian Romanchuk 2023

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