Fed stays hawkish but moves to data dependent mode

However, a clear tightening bias remained: “In determining the extent to which additional policy firming may be appropriate to return inflation to 2 percent over time, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments.” Overall, the outcome was in line with our expectations.

Powell maintains caution while emphasising inflation risks

In the press conference, Chair Powell continued to express caution over the effects of the banking sector turmoil on the outlook, noting that lending standards do appear to have tightened in response, but that the persistence and extent of this tightening remains unclear. He also noted the clear cooling in the economy and in the labour market over the past few months, while acknowledging that the labour market “remains very tight.” Indeed, Powell pushed back on the prospect of near-term rate cuts, given that inflation pressures “continue to run high,” and he reiterated that “the process of getting inflation down has a long way to go.” When questioned on the likelihood of recession, Powell stated that the Fed staff’s March expectation of a mild recession was broadly unchanged at this meeting, but he continued to express his own view that the economy may yet go against historical precedent and that inflation could return to target without a recession. Supporting this notion, he pointed to the significant decline in job vacancies which has happened – so far – without a rise in the unemployment rate. We think a recession will be unavoidable to bring inflation sustainably back to target.

Fed in full data-dependent mode from here on

On the prospect of future rate hikes, Powell stated that the Fed would take a ‘data dependent approach’ and that it would be an ‘ongoing assessment’ whether the Fed had tightened enough to bring inflation back to target. At the same time, given the inflation risks, it is clear from both the statement and Powell’s remarks that the bias is still tilted toward further rate hikes rather than rate cuts. Our base case is that the Fed indeed keeps policy on hold for much of the remainder of this year, with a rate cutting cycle expected to start in December – later than current market pricing which suggests cuts will start in September. This assumes that the economy cools more significantly, and that a mild recession unfolds over the coming quarters. (Bill Diviney)