Fed Anticipates Mild Recession in 2023 Due to Banking Sector Developments
The Federal Reserve (Fed) released the minutes from its March 21-22 monetary policy meeting, which revealed that the central bank expected a “mild recession” later this year before the economy would recover over the next two years. Fed economists projected this outcome due to “the potential economic effects of the recent banking-sector developments.” The banking sector concerns led Fed officials to scale back their expectations for rate hikes and consider pausing the rate-hiking campaign. While all Fed policymakers supported the 25-basis-point interest rate increase, several considered a pause before agreeing to tighten monetary policy. The minutes also showed that some officials would have considered a 50-basis-point rate hike in the absence of the banking sector developments. However, due to the potential for these developments to tighten financial conditions and weigh on economic activity and inflation, they judged it prudent to increase the target range by a smaller increment at this meeting.
The recent rise in interest rates by the Fed has elevated the federal funds rate to a range of 4.75% to 5%, marking the highest point since September 2007. The potential conclusion of the Fed's rate-hiking efforts may be indicated by a combination of banking stress, as well as a decline in inflation and a less active labor market. Since March, banking concerns have eased, and inflation data showed the Consumer Price Index slowed to 5% in March, the lowest since May 2021; however, the Core rate edged higher to 5.6%.
Federal Reserve policymakers debated between keeping its policy rate unchanged or raising it by another 25 basis points, but ultimately all the voting members of the Federal Open Market Committee decided to raise its key rate by 25 bps to 4.75%-5.00%. Fed officials released papers detailing the minutes from their March meeting of the Federal Open Market Committee. Staff members at the central bank, who brief policymakers before interest rate decisions, had long expected GDP growth to slow this year in the wake of the Fed's fight against inflation. In March, they said the banking crisis heightened that forecast to a recession.
Recent developments in the banking sector “were likely to result in tighter credit conditions for households and businesses and to weigh on economic activity, hiring and inflation,” though policymakers were unsure of the extent of the economic fallout, according to the minutes. The collapse of Silicon Valley Bank was the second-largest bank failure in US history and underpins the worst banking crisis since the Great Recession. Signature Bank was the other casualty of the US banking industry's turmoil last month, and Swiss banking giant Credit Suisse was forced to merge with its longtime rival UBS as a remedy.
The release of the Fed's meeting minutes caused US stock indexes to turn lower, reversing earlier gains. The Dow Jones Industrial Average shed 47 points, or 0.1%, to 33,633, while the S&P 500 lost 0.4%, and the Nasdaq Composite dropped 0.7%. The Dow Jones Industrial Average futures saw a decline of 60 points, equivalent to 0.2%, and the Nasdaq 100 futures experienced a slight drop of 0.1%. The S&P 500 futures dropped by approximately 0.2%.
According to Nancy Davis, founder of Quadratic Capital Management, the “main takeaway from Wednesday's Federal Reserve minutes is that the central bank anticipates a mild recession in late 2023, and that the soft landing window seems to be closing quickly.” While Fed Chair Jerome Powell stressed that the banking industry remained sound, “such a tightening in financial conditions would work in the same direction as rate tightening,” he said.
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