At the Federal Open Market Committee (FOMC) meeting on March 22, the US Federal Reserve increased interest rates by 25 basis points. The Fed’s view is that inflation remains too high and the labour market continues to be very tight; however, problems in the banking system are expected to result in tighter credit conditions for households and businesses. This has led the Fed to change its perspective from anticipating that “ongoing rate increases will be appropriate to quell inflation” to “some additional firming may be appropriate.”
In his press conference, Fed Chairman Jerome Powell stated that “firming” refers to interest rates, and the market should focus on “some” and “may.” We take that to mean that the Fed is done with tightening, and if rates are hiked further, it won’t be by much.
The rapid increase in interest rates has caused cracks in the financial system. Market expectations around peak rates fell on the hope that central banks would come to the rescue and cut rates – as was done during the 2008 financial crisis. We expect central banks will continue to fight stubborn inflation and use other tools to deal with any banking system problems.
We don’t see a repeat of the 2008 financial crisis – the banking stresses currently roiling markets are different, and banking regulations are much stricter now. However, to bring down inflation, central banks have had to raise rates high enough to cause economic damage. This has underscored some troubles at US mid-sized banks and raised concerns over some large European financial institutions.
What are the implications for financial markets?
- Expect ongoing volatility in the market as it tries to figure out if the Fed is near the end of its rate-hike cycle and if there will be additional stress in the banking sector.
- Over last week, Canada’s 5-year bonds moved nearly 20 basis points lower. On Monday, the market had given back half these gains. Over the near term, with the Bank of Canada on the sidelines, we expect Canadian rates will closely follow US rates.
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