US Fed policy preview: FOMC may deliver a dovish 25 bps rate hike, will it be the last?

Chair Jerome Powell and other committee members of the Federal Reserve are likely to deliver a quarter-point hike in key rates on Wednesday. This is expected to be the final hike of the aggressive rate hike cycle that began in early 2022. The inflation is still stubbornly "high" but it would be the latest banking stress that is seen to create more havoc for the economy than a dovish 25 bps hike. Hence, apart from a hike, the Fed is also expected to loosen it's monetary policy tightening biases.

FOMC's 2-day meeting has commenced from May 2nd and the outcomes will be announced on May 3rd.

In the previous policy, despite two regional banks Silicon Valley and Signature Bank's failure on American soil, the Fed raised key funds rates by 25 bps in the range of 5% to 5.25%. This is the highest level in federal fund rates since 2007.

US inflation eased for the ninth consecutive month in March to 5%, however, came in below market estimates. Inflation is still above the Fed's target of 2%.

In its preview note, Dutch multinational banking and financial services provider ING said, "Inflation remains 'unacceptably high', but banking stresses are leading to a tightening of lending conditions, which will do more to slow the economy than the likely 25bp hike on Wednesday. While the Fed will leave the door ajar for further hikes, the need for higher policy rates is highly questionable."

Read here: Will US Fed hike rates in May? What would the decision mean Indian market?

The Fed's minutes of the March meeting hinted that inflation was s “unacceptably high” and that a “period of below trend growth (was)needed” to get it back to the 2% target.

Since March, ING highlighted that, inflation has continued to run hot and the jobs market is tight while first-quarter GDP was headlined by strong consumer spending. Moreover, Federal

Reserve officials’ comments have changed little over the past month, other than hints that the impact on credit conditions is being more readily acknowledged, with some officials, including the likes of Atlanta Fed President Raphael Bostic, openly talking about one more hike and then a pause.

Further, ING's note said the "graphic above shows the different scenarios that are likely in play for the May

FOMC meeting and what we expect to happen. A no-change decision would be seen as very dovish given the Fed commentary over recent weeks."

This would suggest that the Fed has received news that the latest banking stresses are causing major issues and this would be the catalyst for a sharply weaker dollar and lower Treasury yields. However, ING does not believe we are there yet.

Nevertheless, it added, "the uncertainty and nervousness that banking stresses are causing rule out a very hawkish 50bp hike. We are forecasting a 25bp hike on 3 May, which is the consensus view."

Read here: First Republic becomes second-largest ever US bank failure, JP Morgan to take over assets

Meanwhile, Normura's report highlighted that Fed's weekly H4.1 data suggests that the amount of banks borrowing through emergency facilities stayed at elevated levels. Banks’ emergency borrowings from the Fed rose for a second consecutive week, up $11.3 billion to $155.2 billion the week ending 26 April, signaling that significant stress remains in the system.

Further, the data revealed that borrowings through the discount window increased $3.9 billion while borrowing through the Bank Term Funding Program (BTFP) increased $7.3 billion.

The latest bank to fail would be First Republic Bank this week and just like for Silicon Valley Bank and Signature --- a lifeline has been pumped into this collapsed lender through a government-initiated deal. This time it is JPMorgan Chase at rescue by agreeing to acquire First Republic's substantial majority of assets including approximately $173 billion of loans and approximately $30 billion of securities.

Read here: Uday Kotak hails JPMorgan after First Republic Bank collapse, asks India to learn from US

Nomura's note said, "There appears to have been uptake in emergency borrowings at the SF Fed region, even after adjusting for the impact of quantitative tightening, which might be related to continued news of stress at the First Republic Bank."

Taking this into account, Nomura also expects another 25bp rate hike at the upcoming May FOMC meeting. However, the expected 25bp rate hike at the May meeting will likely be accompanied by a removal of tightening biases from the post-FOMC statement.

Nomura continues to expect the May rate hike to be the last in the current hiking cycle, and the first rate cut to take place in March 2024.

ING expects a 100 bps rate cut from Fed in the current year. It forecasts a 50 bps rate cut each in November and December FOMC meetings.

Disclaimer: The views and recommendations made above are those of individual analysts or broking companies, and not of Mint. We advise investors to check with certified experts before taking any investment decisions.