The direct spillover effects of banking sector turmoil and the information it provides about the lagged effects of past tightening mean we have reduced our forecast for the terminal policy rate. But we think the market has moved too far in pricing not even a full additional rate hike.
  • The collapse of Silicon Valley Bank (SVB) and wider banking sector turmoil have seen the market dramatically reprice the near-term path of Fed policy.
  • The market has pivoted from pricing in a higher terminal rate on the back of robust growth and inflation, to contemplating the first cut to rates within months.
  • While it is hard to have conviction amid volatile pricing, we think these moves are an overreaction. The inflation picture is still concerning and the Fed wants to avoid the appearance of financial dominance.
  • We still expect further hikes after that, but we see rates peaking lower than previously forecast, at a target range of 5.25-5.5% in June.
  • Avoiding a systemic crisis is not the same thing as avoiding large spillovers. Financial conditions are tightening and sentiment will take a hit.
  • Moreover, SVB’s failure and ensuing turbulence are a reminder that the full impact of the Fed’s rapid tightening over the last year is only now being felt by the economy.
  • Rising rates cause and expose structural vulnerabilities in the economy. That is why our baseline has long been called ‘Fed kills the cycle’, and this episode increases our conviction that this cycle will end in a recession.

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