Last week the Federal Reserve concluded its ninth monetary policy meeting since it began raising interest rates last March. Amidst heightened fears about the health and stability of the global financial system, the outcome of this meeting seemed more in doubt than any other during the current hiking cycle. Here are some of the key points we took away from the meeting.

1. The Fed Hiked Rates by 0.25%

Monetary policy is set by a group within the Federal Reserve known as the Federal Open Market Committee (FOMC). The Committee, which is comprised of Chairman Jerome Powell and other high-ranking officials, conducts two meetings each quarter (roughly every six weeks). At the conclusion of their most recent meeting last Wednesday (3/22), Committee members unanimously voted to increase the target federal funds rate by 0.25%. This pushed the target rate to a range of 4.75% to 5.00%, the highest level since September 2007.

The Fed has hiked the target rate by 4.75% over the past nine meetings, which reflects an unusually fast pace of tightening relative to recent decades. By last November, however, they began to telegraph a slowdown in its pace, following four consecutive increases of 0.75%. As signs continued to reflect a cooling of economic activity and price pressures late last year, the Fed slowed to 0.50% in December, followed by 0.25% in early February.

Changes to the Federal Funds Rate:

• 03/16/2022: +0.25% increase
• 05/04/2022: +0.50% increase
• 06/15/2022: +0.75% increase
• 07/27/2022: +0.75% increase
• 09/21/2022: +0.75% increase
• 11/02/2022: +0.75% increase
• 12/14/2022: +0.50% increase
• 02/01/2023: +0.25% increase
• 03/22/2023: +0.25% increase

Following the meeting in early February, incoming economic data began to heat up again. As a result, Chairman Powell warned that a reacceleration in the pace of hikes was likely during his semi-annual Congressional testimony on monetary policy. Following the testimony, the market began pricing in another 0.50% hike. Within days, however, the turmoil in the banking system came to a head, leading to the failure of Silicon Valley Bank, Signature Bank, and Credit Suisse. With the heightened volatility, the market’s expectation fell back down to 0.25%.

2. The Fed Acknowledged We May Be Near the End

Coming out of the meeting last week, there were signs the Fed was likely nearing the end of the hiking cycle. First, certain language that had been included in the post-meeting statements was softened noticeably.  The revision removed a statement asserting “ongoing increases in the target range will be appropriate…,” and replaced it with “more policy firming may be appropriate…” Investors scour these post-meeting statements for subtle clues about the future path of policy. This updated language demonstrates an obvious shift toward a less aggressive, albeit uncertain, path.

Additionally, Powell commented on the fact that the banking turmoil would likely lead banks to tighten credit availability, which could ultimately do part of the Fed’s job for it.

We’re looking at what’s happening among the banks and asking, is there going to be some tightening in credit conditions, and then we’re thinking about that as effectively doing the same thing that rate hikes do. So, in a way, that substitutes for rate hikes.

– Federal Reserve Chairman Jerome Powell

Many pundits doubted the Fed would even hike at this meeting, given the apparent instability of the banking system. During the Q&A portion of the press conference, he fielded a question directly related to this concern. Powell’s response indicated that the Committee wanted to focus its use of monetary policy on addressing the problem of inflation. If the need arises to further shore up confidence in the banking system, he believes they can continue to rely on the financial stability tools like the lending facilities and deposit guarantees that were rolled out in the aftermath of recent bank failures.

Finally, once a quarter, the FOMC publishes an updated Summary of Economic Projections (SEP). The SEP provides the median estimate among Committee members for a handful of data points, including GDP, unemployment, and inflation. Another component of the SEP is known as the ‘dot plot,’ which is a graphical illustration of the expected path of the federal funds rate over the next couple of years.

As the dot plot (shown above) illustrates, the median estimate for the federal funds rate at the end of 2023 falls between 5.00% – 5.25%, which implies just one more 0.25% hike from current levels. It’s worth noting that while signs seem to indicate the rate hike cycle may be coming to an end, Powell made it a point to say the Fed would not hesitate to continue to increase rates if they felt it was necessary to bring inflation down to their 2% target.

3. The Market Is Expecting Cuts

While the Fed anticipates that the end of its rate hiking cycle may be near, the market’s expectation appears to be way ahead. The market is currently pricing in no additional hikes, with cuts likely beginning by September. If the market is getting ahead of itself by prematurely pricing in the start of an easing cycle, there could be some volatility as expectations for rates correct higher.

Interestingly, while the Federal Reserve has direct control over the level of the federal funds rate, the market’s pricing of fed fund futures has consistently been more accurate than the Fed’s projections. Updates to the dot plot since late 2021 have generally included sharp upward revisions in the Fed’s expected future level of the target rate. This provides yet another example of the folly of trying to outsmart the market. An institution overflowing with Ph.D. economists can’t predict its own actions as well as the market can.

As we have seen over the past few months, the outlook can change on a dime. We ended 2022 with the widespread belief that tighter policy was making headway in cooling inflation. By February and March, that view was flipped on its head after the economic data once again began to heat up. Just days later, there was yet another reversal as the banking turmoil took center stage.

The main lesson here for investors is that you should take the market’s mood and outlook on any given day with a grain of salt. Adjusting your asset allocation in response to the news of the day will leave you exposed when market sentiment shifts inevitably anew.