AMSCI NEWSLETTER March 2023

In the end, the Fed met the most common expectations by raising rates by 0.25 points, bringing the target range for the Federal Funds Rate to 4.75-5 percent. At the same time, though, it released projections implying that the increases are likely to stop after one more quarter-point hike. In addition, it dropped from its announcement a statement that it “anticipates that ongoing increases in the target range will be appropriate” – language that had been commonly used following recent increases – choosing instead to say that it “anticipates that some additional policy firming may be appropriate.”

While stating that “The U.S. banking system is sound and resilient,” the Federal Reserve hinted in the announcement that the – to this point, at least – isolated bank failures might accomplish what the Fed has been trying to do with interest rate manipulation: rein in rapid price increases.

“Recent developments are likely to result in tighter credit conditions for households and businesses and to weigh on economic activity, hiring, and inflation,” the central bank stated.

While inflation has eased since last summer, year-over-year prices were still up by 6 percent in February, down from 6.4 percent in January, according to the Labor Department’s Consumer Price Index. However, core inflation, which excludes food and energy prices, rose at the fastest monthly rate (0.5 percent) since September.

“The recent data indicate that we haven’t made as much progress as we thought,” Christopher Waller, a member of the Federal Reserve Board of Governors, said.

An additional complicating factor for the Fed is that, as many analysts have been pointing out, interest rate hikes are connected to bank failures. As a West Virginia University finance professor explained in Fortune, Silicon Valley Bank – like many other financial institutions – held large amounts of long-term government securities, which exposed it to “interest rate risk.”

“SVB was forced to sell $21 billion worth of securities that lost value because of the Fed’s rate hikes at a loss of $1.8 billion, sparking its crisis,” the professor wrote. “When SVB’s depositors got the wind of it and tried to withdraw $42 billion on March 9 alone – a classic bank run – it was over. The bank simply couldn’t meet the demands. But the entire banking sector is sitting on hundreds of billions of dollars’ worth of unrealized losses – $620 billion as of Dec. 31, 2022. And if rates continue to go up, the value of these bonds will keep going down, which fundamentally weakens banks’ financial situation.”

Not surprisingly, it appears that the past year’s rate increases are also being felt in the housing market. The median price for existing homes in February decreased on a year-over-year basis for the first time in nearly 12 years. The National Association of Realtors reported that prices declined by 0.2 percent from February 2022 to $363,000. Existing home sales, meanwhile, increased on a month-over-month basis for the first time in a year, jumping 14.5 percent, the largest monthly growth since July 2020.

“We’re seeing stronger sales gains in areas where home prices are decreasing and the local economies are adding jobs,” the association’s chief economist said.

Housing starts in February increased nearly 10 percent from January but were 18.4 percent lower than a year earlier, according to the Census Bureau and the Department of Housing and Urban Development.

Notwithstanding all of the economic challenges and confusing signals, the one constant since the recovery from Covid lockdowns began in mid-2020 has been significant job growth. In February, the economy added 311,000 jobs, according to the Bureau of Labor Statistics. The unemployment rate is now at 3.6 percent.

“Notable job gains occurred in leisure and hospitality, retail trade, government, and health care,” the bureau reported. “Employment declined in information and in transportation and warehousing.”

Despite the continuing strength in the labor market, consumer confidence dipped in February for the second straight month, The Conference Board reported.

“Expectations for where jobs, incomes, and business conditions are headed over the next six months all fell sharply in February,” the board’s senior director for economics said. “And, while 12-month inflation expectations improved – falling to 6.3 percent from 6.7 percent last month – consumers may be showing early signs of pulling back spending in the face of high prices and rising interest rates.”

Another confidence measure, the Index of Consumer Sentiment from the University of Michigan, declined from February to March, the first decrease in four months.

Confidence is not much better in the business community. While the Institute for Supply Management’s Purchasing Managers Index rose for the first time since August, the increase was slight and the overall reading remained below the

threshold indicating economic growth.

“With Business Survey Committee panelists reporting softening new order rates over the previous nine months, the February composite index reading reflects companies continuing to slow outputs to better match demand for the first half of 2023 and prepare for growth in the second half of the year,” the chair of the institute’s Manufacturing Business Survey Committee said.

The Dow Jones Industrial Average closed at 32,030.11 on March 22, down 3.4 percent on the year. The S&P 500 Index ended March 22 at 3,936.97, recording a year-to-date gain of 2.5 percent.

The dollar on that day was trading at 0.92 euros, 0.81 pounds, 130.54 yen and 6.84 yuan.

In late-April, the Bureau of Economic Analysis will announce its estimate of economic growth during the first quarter. Predictions tend to be in the neighborhood of 1 percent (on an annualized basis), which might just be the economic sweet spot. Much lower and the economy could be sinking into a recession; much higher and there is a good chance that the Federal Reserve will return to a more aggressive interest rate hike schedule.