Weekly Market Update: April 3, 2023

The Federal Reserve remains on its monetary policy tightening course. At the March Federal Open Market Committee (FOMC) meeting, the central bank raised the benchmark short-term interest rate by a quarter point, to 4.75%-5.00%. The bank noted that stubbornly high inflation, which is still running well above its target rate of 2.0%, was the main reason for another hike to the federal funds rate.

Federal Reserve policymakers are walking a tightrope in the battle to tame prices. Inflation showed signs of moderating in February, but the lead bank’s most restrictive monetary policies in four decades have put stress on the banking system both here and abroad. The higher rates led to a liquidity crunch at a few regional banks and raised concerns about the safety of deposits at those institutions. The Federal Reserve and the Federal Deposit Insurance Corporation (FDIC) had to step in to guarantee those accounts, but talks of a possible contagion still linger.

There is a growing disconnect between the Federal Reserve’s and Wall Street’s view on future monetary policy. The Fed may pause at its next FOMC meeting if inflation continues to ease, but Chairman Jerome Powell said a pivot on interest rates (in other words, reductions) is unlikely this year with inflation still running well above the Fed’s comfort level. However, Wall Street is pricing in interest-rate cuts, perhaps as early as the June FOMC conference, given the banking system worries and the growing expectation that the economy is headed into recession.

The U.S. economy is showing further signs of slowing. In addition to housing and manufacturing weakness, the consumer is now exhibiting some hesitation to spend on certain items, with retail sales and durable goods orders (i.e., products typically with a life of more than three years) falling in February. Higher borrowing costs, specifically on credit cards, are making purchases more expensive to finance. Could the credit crunch witnessed at the regional banks extend to the consumer? The Fed will need to closely monitor this situation.

Conclusion: Given the high uncertainty on Wall Street these days, including worries about the global banking system and outcomes if the Fed oversteps on the monetary policy tightening front, we recommend investors proceed with considerable caution. 

Source: ValueLine.com