Things Get Complicated for ‘Data-Dependent’ Fed amid Banking Crisis


The next Fed meeting is scheduled for March 21-22. While on multiple occasions the US central bank has said that it is “data dependent” it might also factor in the troubles in the banking sector during the rate hike decision.

After the 25-basis point rate hike on February 1, the Fed raised interest rates to 4.50-4.75%, which is the highest since October 2007. Market expectations from the upcoming Fed meeting have whipsawed over the last few days.

Looking at the CME Fed Watch tool, around a third of traders expect the Fed to maintain rates at current levels. However, the remaining two-thirds see a 25-basis point rate hike at the meeting.

Data-dependent Fed faces a crucial test

Fed chair Jerome Powell has said multiple times that the US central bank is “data dependent.” He reiterated his stance in his Congressional testimony, and said “We will continue to make our decisions meeting by meeting, taking into account the totality of incoming data and their implications for the outlook for economic activity and inflation.”

Notably, between the Fed’s January meeting and the last week’s Congressional testimony, several data points showed that a lot needs to be done to tame inflation. For instance, in January, US CPI rose at an annual pace of 6.4% which was ahead of estimates. The wholesale inflation also surpassed estimates.

Also, the initial reading showed that US retail sales rose 3% in January which meant that consumer spending remained robust despite Fed’s rate hikes.

Powell’s Congressional testimony spooked markets

In his Congressional testimony, Powell said, “Although inflation has been moderating in recent months, the process of getting inflation back down to 2 percent has a long way to go and is likely to be bumpy.”

Powell added, “The latest economic data have come in stronger than expected, which suggests that the ultimate level of interest rates is likely to be higher than previously anticipated.”

He also emphasized that if needed the Fed was prepared to increase the pace of hikes. After Powell’s testimony, the odds of a 50-basis point rate hike at the Fed’s March meeting increased and it looked like the most likely outcome.

SVB failure could impact Fed rate hike decision

Meanwhile, the failure of SVB and Signature Bank could influence Fed’s rate hike decision. Bond Guru Jeffrey Gundlach said that the Fed might raise rates by 25 basis points in March to save its “credibility” but would pause thereafter.

Goldman Sachs believes that the US Fed would not raise rates at its upcoming March meeting. That said, Goldman still expects the Fed to raise rates by 25 basis points each in May, June, and July which would take the Fed fund rates to between 5.25%-5.50%.

Ed Hyman of Evercore ISI believes that the Fed should take a breather on rate hikes for now. Here it is worth noting that Powell has said multiple times that the US central bank is committed to lowering inflation to its targeted 2%.

Mark Zandi of Moody’s Analytics also believes that the Fed would not raise rates in March. However, like Goldman Sachs, he believes that the US central bank might again embark on rate hikes in upcoming meetings to lower US inflation.

US February inflation was in line with estimates

Meanwhile, US inflation rose at an annualized pace of 6% in February which was in line with estimates. While inflation is still running way above Fed’s target it has fallen on a YoY basis in every month after peaking at 9.1% in June 2022.

US retail sales also fell 0.4% in February which was worse than expected even as the January retail sales data was revised upwards to show a rise of 3.2%.

The US job market meanwhile continues to show strength. In February, the US economy added 311,000 jobs which were ahead of the 225,000 that the market was expecting. The strong economic data and sticky inflation show that the Fed has a long way ahead in reducing inflation to 2%.

Strong job markets make the job tougher for Fed

The Labor Department revised the January nonfarm payroll to show that the US economy added 504,000 new jobs which was lower than the previous reading of 517,000. Nonetheless, the reading still looks quite strong.

Last month, referring to the January nonfarm payroll data, Powell said, that the jobs report was “certainly strong—stronger than anyone I know expected.”

He also said that a strong job market and wage growth make the Fed’s job of lowering inflation tougher.

He reiterated similar comments in his testimony and said, “Although nominal wage gains have slowed somewhat in recent months, they remain above what is consistent with 2 percent inflation and current trends in productivity. Strong wage growth is good for workers but only if it is not eroded by inflation.”

Data-dependent Fed faces a crucial test

To sum it up, the recent data points show that while Fed’s rate hikes have helped lower inflation, a lot still needs to be done to bring it back to 2%. However, while the data would warrant more rate hikes, the US central bank might also consider the trouble brewing at regional banks.

As Sal Guatieri, a senior economist at BMO Capital Markets in Toronto said, “the Fed now has bigger fish to fry, making next week’s decision less dependent on the data and more reliant on how the banking turmoil evolves.”

Oren Klachkin, lead U.S. economist at Oxford Economics in New York also echoed similar views and said “recent bank failures and the spike in financial market stress are complicating policymakers’ task of reading the economic tea leaves.” Klachkin added, “A pause in the hiking cycle would be premature as inflation continues to run hot and GDP growth remains resilient.”