In line with expectations, the FOMC unanimously voted for a 25bps rate hike on Wednesday evening, taking the upper limit of the Fed Funds Target Rate to 5.25%. In terms of the policy statement, the most notable change from the March statement was the removal of the clause “the committee anticipates that some additional policy firming may be appropriate.” Markets assessed this as a signal that this marks the final rate hike in the current cycle.

While the FOMC signalled that this could be the peak of the current tightening cycle, with a pause seen as the most likely outcome in June, policymakers left the door open for more tightening if conditions warrant. The Fed noted that the labour market conditions remain extremely tight. Moreover, in contrast to the Fed staff survey, Powell said that it is likely that the US will avoid a recession this year. The FOMC omitted language characterizing rates as “sufficiently restrictive.”

Fed Chair Powell suggested that the Fed expects a softening in labour demand and a gradual cooling in the market without causing a recession. Powell reiterated that inflation would need to slow for a prolonged period before the Fed even considers a pivot in monetary policy. Powell signalled that rates are likely to remain on hold at current levels for an extended period of time as the central bank waits for the delayed effects of the aggressive tightening to take hold. This didn’t deter markets from pricing in significant rate cut risk in the second half of the year with at least two 25bps rate cuts priced in.

In summary, the market reaction suggests that the statement was assessed to be dovish, while the presser was seen as hawkish. This was reflected by the drop in the 2yr US Treasury yield in the minutes following the release of the statement, with the moves then reversing during Powell’s presser as he reiterated that the Fed remains committed to its primary mandate of price stability.

There were a number of points raised about the health of the US banking sector and concerns over the US debt ceiling and what a US government default could mean for financial markets. Powell said in his presser that it is essential that the debt ceiling is raised to prevent the US government from defaulting on its debt. Meanwhile, the state of the US banking sector was deemed to be healthy.

The last time rates were at this level was in 2007 when the upper bound of the Fed Funds Target Rate sat at 5.25% for 14 months before the Fed slashed rates aggressively in response to the GFC. Recall that the FOMC slashed rates by 500bps during the GFC to 0.25%. While there has been a significant improvement in financial market regulation since the GFC, cracks are emerging in the US financial system, such as the recent banking wobble, which raises questions if we could see a repeat of the monetary policy swings seen in 2007 through to 2009. Looking ahead, incoming inflation, labour market and credit conditions data will be key drivers of future policy moves.