The Federal Open Market Committee hiked rates by 25 basis points (bps) and kept its quantitative tightening plans in place. It did acknowledge that financial conditions have tightened and progress has been made on inflation. However, it seems to think it can simultaneously tighten monetary policy to fight inflation while providing support to the financial system. The Federal Reserve (Fed) may be living on a prayer instead.

Since March 2022, the Fed has done a lot, and the economy and the markets have gone through a lot. While there are lot of other indicators that matter, listed below is a sampling of where we’ve been and where we are now.

  • The federal funds rate upper-bound target has increased from 0.50% in March 2022 to 5.00%.
  • The average rate on a 30-year fixed mortgage rose from 4.52% in March 2022 to a peak of 7.35% in November 2022 and down to 7.00% as of March 17. New-housing starts dropped 15.2% from February 2022 to February 2023.
  • The Fed’s balance sheet shrunk by 3.5% from the end of March 2022 through March 15, 2023. During that same timespan, deposits at U.S. commercial banks shrunk 2.9% while deposits at large commercial banks fell 5.9%. Money market assets increased 10.0%.
  • Consumer prices rose 6.0% from February 2022 through February 2023, but nominal incomes rose only 5.9%.
  • The S&P 500 Index declined more than 11% from March 17, 2022, through March 17, 2023.

So, what’s to come? We can only make educated guesses, but based on the Fed’s latest decision, we think it’s reasonable to assume the following:

  • As the Fed shrinks its balance sheet, bank deposits are likely to keep falling. That will eventually show—perhaps quickly—in tighter lending standards.
  • Loans and credit help fuel economic activity and inflation. As lending and credit conditions tighten, we could see an early onset of a recession compared with what the market was pricing in (a late-2023 or early-2024 event). On the bright side, a financial crunch coupled with an economic slowdown should make inflation fall quickly.
  • The giant cloud behind the silver lining of lower inflation is a recession. The Fed has talked a lot about how lower-income individuals tend to be harmed most by high inflation, but they are also the ones who tend to be harmed the most during recessions.
  • Earnings and margins are likely to fall more, creating increased downside risks for equities.
  • If inflation falls and growth contracts, that could be bullish for bonds.


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