The US dollar remained near its five-week low as investors await the highly anticipated Fed decisions later on the day. As global banks face increasing instability, markets are eagerly anticipate clarity on how the FOMC will react in order to ensure stability.
Investors remain skeptical on whether the Fed will continue its rate hiking cycle to combat stubborn inflation or if it will pause interest rate hikes due to a string of recent banking turmoil, such as bankruptcy and emergency bailouts.
Financial markets had a bumpy ride, initially reacting to the Federal Reserve’s hawkish stance and then later being roiled by contagion fears in the banking sector.
Just two weeks prior, Powell stated before the congress committee that the Federal Reserve may have to raise interest rates more than anticipated in order to contain high inflation.
Just a few days later, the unexpected failure of Silicon Valley Bank had an intense impact on markets; bond yields plummeted and expectations for Federal Reserve rate hikes shifted completely – from what was anticipated as being a half-point rise two weeks ago, discussion has now turned towards either increasing it by only a quarter point or not raising it at all.
Fed officials will be concluding their two-day meeting on Wednesday with multiple options on the table. Markets are split on how the FOMC will react given the recent banking turmoil that spurred fears on a loaming financial crisis.
But first, let’s have a look on the economic performance.
Economic Overview
Inflation
In February, the US annual inflation rate slowed to 6%, its lowest level since September 2021. This reading came in line with market expectations and marked a decrease from January’s figure of 6.4%. Core inflation, which excludes the volatile prices of food and energy, mildly declined to a rate of 5.5% from its previous level at 5.6%.
On a monthly basis, the Consumer Price Index (CPI) rose by 0.4% from the previous month, in line with expectations and following a prior increase of 0.5%. Additionally, the core rate increased to 0.5%, surpassing forecasts of only a slight uptick to 0.4%.
The US inflation rate is currently threefold higher than the Federal Reserve’s target 2%.
Labor Market
The US economy added an impressive 311K jobs in February, drastically surpassing expectations of 205K, while January’s reading saw a downward revise to 504K.
The data continues to point towards a tight job market, with the economy being able to add an average of 343K new jobs every month in the past six months.
Given that adding over 100,000 jobs each month in enough to keep up with the growing workforce, the US labor market is in a very good shape.
The US unemployment rate rose to 3.6%, signifying a slight increase from January’s 50-year low of 3.4%. This was slightly higher than what analysts’ estimated figure of 3.4%. The 4-week average of Jobless Claims dropped to 196.50 Thousand during March 11th from 197.25 Thousand in its preceding week, demonstrating a slight yet notable decrease in unemployment rates.
Economic Growth
The Bureau of Economic Analysis’s second estimate unveiled that real gross domestic product rose at an annual rate of 2.7 percent in the fourth quarter of 2022, which was notably lower than the 3.2 percent increase seen in the third quarter.
Tough Decision amid Financial Instability
With an unprecedented task ahead of them, the Federal Open Market Committee’s mission is getting tough with numerous complex issues to consider, such as analyzing economic conditions in light of recent financial turmoil, deciding on interest rates and prioritizing financial stability amongst others.
The Federal Open Market Committee will also be releasing their updated dot plot, potentially further complicating the situation.
California-based Silicon Valley Bank (SVB) and New York’s Signature Bank were both devastated by the repercussions of their bond portfolios being unable to handle the losses, along with a consequential deposit withdrawal. Since 2008, these banks have been the most significant to collapse in the U.S.
In order to contain the financial damage from Silicon Valley Bank and Signature Bank’s collapse, Federal regulators intervened by guaranteeing deposits and providing favorable loans for up to one year. On Sunday, global central banks joined forces with the Fed in order to improve liquidity through a standing dollar swap system; this action was taken after UBS agreed on buying Credit Suisse.
The FOMC is weighing options to how best employ interest rate tools while attempting to calm markets and avoid any additional banking chaos. Unfortunately, increasing rates could create more insecurity for banks, leading them to cut back on loaning money, ultimately resulting in a detriment of small businesses and people who rely on loans.
Investors will be eagerly awaiting reassurances from Fed Chairman Jerome Powell that the central bank is adequately equipped to tackle any potential banking issues.
FOMC Preview – What to Expect
As the Federal Reserve prepares to raise interest rates by a quarter point, it must also strive to soothe concerns on a potential banking crisis.
Although many sees that it may be wise to take a step back and assess the consequences of recent banking failure following the SVB collapse, the Federal Reserve is seen focused on taming stubborn inflationary pressures. Accordingly, a 25 basis points rate hike is widely expected from today’s meeting.
Possibilities for a 25 bps rate hike are anchored at 87.8% according to CME’s FedWatch Tool. Meanwhile, future markets anticipate a similar size rate cut by 12.2%.
While a rate hike is widely priced in, investors will be keenly observing Chair Powell’s press conference and updated dots plot for any clues of an impending shift or pause in their current tightening cycle.
As the cost of borrowing rises, both economic growth and inflation are likely to reverse their course, allowing for potential rate cuts during H2 2023.
US Dollar Targets 103
As the Federal Reserve prepares to decide on interest rates later in the day, investors have become increasingly confident that a more conservative policy will be adopted.
Currently it is speculated that a 25 basis point rate hike may take place, while some experts are wagering on no action at all, keeping the DXY near five-week lows.
The US Dollar Index (DXY), which gauges USD strength against some of its major competitors, continued to trade within a tight range near the 103.00 mark, with 0.20% daily losses.
The greenback witnessed widespread losses against rivals, while strengthening against the Yen.
