Yesterday, 7 March 2023, Jerome Powell, the Federal Reserve Chairman, testified before the Senate Banking Committee—which happens twice a year during The Semiannual Monetary Policy Report to Congress.
On 1 March 2023, the market deemed a 70% probability that the Fed would increase the target rate 25bps, to a range of 475-500bps. Following Powell’s two-hour-long testimony, markets placed over a 70% probability of a 50bps increase, or a range of 500-525. Further, markets slid modestly, with the S&P 500 declining around 1.6% from the open over the trading day.
A few factors have shifted the market’s interest rate conviction.
- Powell’s statements of the possibility of a 50bps increase—This is likely the main driver of the market’s fresh outlook on monetary policy and interest rates. Fed signaling is a hypothetical tool used by the central authority to communicate with the market and dampen market volatility. Historically, when the Fed, namely the chairman, raises the possibility and amount of a rate increase, it typically happens.
- Strong economic data—Since the 1 February 2023 Fed meeting, multiple data releases have indicated a stronger-than-expected economy, while inflation beat expectations. The US unexpectedly created 517 thousand jobs in February, the highest number since July and above a 2022 average of 401 thousand.
- Good news is bad news—Under the current market regime, good news is considered bad news. For example, a strong labor market report amid increasing consumption would be met with strong selling in risky assets, and it is a reason for the Fed to carry on with rate increases. During Powell’s testimony, he focused on and leverage the strong recent economic reports as a reason for the Fed to shift to higher rate increases.
Given the Fed’s signaling, strong economic data, and a market that rejects good news, a 50bps rate increase is more than likely for the upcoming meeting on 22 March 2023. The only thing that can keep the Fed on its current course of lower increases would be significantly worse-than-expected economic data. Releases to pay particular attention to in the coming days include.
US Non-Farm Payroll—10 March 2023
This will be a closely watched economic data release, especially following February’s surprise beat. Following the 517 thousand increase, the consensus is currently 205 thousand for March’s release.
Core Inflation Rate—14 March 2023
The inflation data indicated a 5.6% year-over-year increase in prices for consumers in January, beating markets’ expectations by 10bps. The current consensus inflation rate in February is 5.6%, consistent with the actual data in January.
Looking beyond the next Fed meeting, the market is currently placing a 58% probability of a target range between 425-550bps, implying a 25bps increase on 3 May 2023 following a 50bps increase at the upcoming meeting. While the market is convinced of an increased hike in March, they don’t believe the Fed will hold that course for long. This conviction speaks to the market’s belief that the Fed’s policy will cool prices and that the economy will reverse course.
The question now is: will the Fed achieve the fabled soft landing? Or is a recession imminent?
Powell returns today, 8 March 2023, for his second day of testifying before Congress.
Thank you.
Please write me at alexander.cappadona@gmail.com.