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Market Briefing: Fed Caught Between Inflationary Devil and Deep Financial Stability Sea

CalendarMarch 22, 2023

Treasury yields, equity bourses, and the dollar are all edging lower ahead of one of the most difficult Federal Reserve meetings in recent memory.

Market-implied odds on a quarter-point move are now over 90 percent, but many bank economists remain convinced a hold is possible. Another hike could well prove to be the straw that breaks the camel’s back, piling additional stress on interest rate-sensitive sectors like technology and commercial real estate. But a pause could signal deeper unease about risks lurking deep beneath the surface of the financial system, triggering widespread panic.

We think policymakers will opt to hike, but nuances in communication around the announcement could prove more important than the decision itself. Officials will use the policy statement, “dot plot” summary of economic projections, and the post-meeting press conference to describe whether recent events have changed the growth and inflation outlook, how risk profiles have shifted, and where the policy path might go. In the statement, financial stability risks might be acknowledged, but the focus will remain squarely on price pressures emanating from labour market tightness and excess demand in a still-robust American economy. The dot plot should show rate expectations and inflation outcomes rising relative to December, even as growth forecasts are revised down. And in the press conference, we expect Jerome Powell to outline a multi-pronged strategy—already deployed by the Bank of England and European Central Bank—using a different tools to target financial stability and inflation risks separately.

We would caution hedgers to avoid overreaction. If recent history is any indication, the market response could flip sign between the statement release and the press conference, with reversals likely to occur throughout the question and answer period. Mr. Powell is an incredibly gifted communicator, but misinterpretations could prove almost impossible to avoid.

Treasury Secretary Janet Yellen will testify before a Senate panel this afternoon, just as Jerome Powell’s press conference gets underway. In a speech at an American Bankers Association event yesterday, she indicated a willingness to backstop deposits at other embattled institutions - words that helped touch off a rally in regional bank shares and support a broad-based recovery in risk appetites.

We’re also keeping an eye on developments with First Republic Bank. Discussions are reportedly underway between regulators and other, better-capitalized banks to help rescue the regional lender, and a positive result could  lift sentiment further - potentially exacerbating or offsetting any reaction to this afternoon’s Fed decision.

The pound is trading near monthly highs against the dollar after inflation accelerated unexpectedly last month, making a hike at tomorrow’s Bank of England meeting much more likely. Data released by the Office for National Statistics this morning showed prices climbing 10.4 percent in the year ended in February, faster than the 10.1-percent pace recorded in January, and well above the 9.9 expected in markets. Relative to the prior month, prices jumped 1.1 percent, nearly double the 0.6 percent increase forecast by economists. Gilts sold off after the print, and bulls piled back into the currency - but we suspect gains could run into headwinds later in the day as the risk of a similar surprise in the US lifts the Treasury curve.




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GBP Consumer Price Index, February

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USD Durable Goods Orders, February, Preliminary

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Karl Schamotta

Karl Schamotta

Chief Market Strategist

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