This could be the likely scenario forcing Fed to cut rates several times before 2023 is over

The recent collapse of several mid-sized banks was addressed early in the statement.

By Taimur Baig

Stressing that labour market tightness persists while inflation remains elevated, the Federal Reserve’s Open Market Committee continued with its path of policy rate hike at the conclusion of its March 21-22 meeting, pushing up the Fed funds rate to 5%.

The recent collapse of several mid-sized banks was addressed early in the statement. While granting that these developments are likely to result in tighter credit conditions for households and businesses and to weigh on economic activity, hiring, and inflation, the FOMC reiterated its concurrent focus on inflation risks.

The FOMC is trying to thread the balance between varnishing its inflation-fighting credentials while displaying cognizance of the impact of the cumulative tightening in this cycle, along the ongoing worsening of financial conditions due to banking system issues.

Possible additional tightening was kept on the table (we think one more 25bps hike is left in this cycle, but odds have weakened given recent developments) while the usual caveat about data dependency was underscored.

We have noted the market’s deepening conviction that policy tightening is about usher in so much softening of economic activity and inflation that the Fed would be bound to cut several times before 2023 is over. We think this scenario is only possible if a major financial system setback ensues, in which banking system distress translates into an acute credit crunch.

We also think that there is enough firepower in the hands of the regulators and sufficient buffers at the household/corporate balance-sheet level to prevent such a scenario from materialising. We maintain our forecast of around 1% growth in 2023, as well as above-target inflation through the year.

(Author is Chief Economist, DBS Bank)