Before turning to other agenda items, the Chair asked the Vice Chair for Supervision to provide an update on recent developments in the banking sector.
The Vice Chair for Supervision described the developments, including those at Silicon Valley Bank, Signature Bank, and Credit Suisse.
He also described actions taken by the Federal Reserve and other regulatory agencies in response. He noted that the U.S. banking system is sound and resilient.
He also noted that he will be leading a review of the supervision and regulation of Silicon Valley Bank, and that the Federal Reserve System will apply what is learned from the review to strengthen its supervisory and regulatory practices as appropriate.
Developments in Financial Markets and Open Market Operations:
The manager turned first to a review of U.S. financial market developments over the intermeeting period. Early in the period, firmer-than-expected data and policy communications pushed interest rates higher and equity prices lower.
Developments in the banking sector later in the period were met with sharp reductions in Treasury yields, particularly at shorter tenors.
Treasury market liquidity was poor and implied volatility was high, but the market remained functional amid substantial trading activity.
Higher Treasury market volatility contributed to wider spreads for household and business borrowing.
Financial conditions tightened considerably over the intermeeting period as a whole.
Market contacts observed that the recent developments in the banking system will likely result in a pullback in bank lending, which would not be reflected in most common financial conditions indexes.
Following the banking-sector developments, equity prices for large U.S. banks underperformed the broad market; equity prices for U.S. regional banks generally underperformed by relatively more.
Regarding the outlook for inflation in the United States, market-based measures of inflation compensation over shorter horizons rose over the period, although compensation retraced a good portion of its increase later in the period as markets reacted to the developments in the banking sector.
Forward inflation compensation measures continued to indicate that longer-term inflation expectations remained well anchored.
Measures of inflation expectations from the Open Market Desk's Survey of Primary Dealers and Survey of Market Participants moved higher at shorter horizons and were little changed at longer horizons.
Regarding the outlook for monetary policy, market-based measures of policy expectations suggested that the federal funds rate would reach a peak in May 2023 and that the target range would then move lower.
However, the medians of respondents' modal expectations of the federal funds rate from the Desk surveys did not show any declines in the target range through the end of 2023.
Risk and liquidity premiums embedded in market prices may have driven a good part of the difference between survey and market measures.
The median respondent expected the Summary of Economic Projections (SEP) projections for the federal funds rate at the end of 2023 and 2024 to shift 25 basis points higher.
However, information gathered after the Desk surveys closed suggests that those expectations had declined some, to a level comparable with the December SEP.
Survey responses suggested only modest changes in expectations for balance sheet policy.
Discussion of operations and money markets:
Federal funds volumes fell sharply for a few days late in the period as Federal Home Loan Banks (FHLBs) sought to maintain liquidity in order to meet increased demand for advances by member banks.
Money market rates remained broadly stable, and secured and unsecured money market rates, including the effective fed funds rate, traded well within the target range.
Use of U.S. dollar liquidity swap lines with foreign central banks had been minimal, indicating that market participants did not face significant difficulties in obtaining dollar funding from private sources.
Borrowing from the new Bank Term Funding Program had been small relative to discount window borrowing, which had increased to record levels.
Use of the overnight reverse repurchase agreement (ON RRP) facility fell, especially for money market mutual funds (MMFs), as the supply of short-term securities at attractive rates increased.
By unanimous vote, the Committee ratified the Desk's domestic transactions over the intermeeting period.
There were no intervention operations in foreign currencies for the System's account during the intermeeting period.
Staff Review of the Economic Situation:
The information available at the time of the March 21–22 meeting indicated that labor market conditions remained tight in January and February, with robust job gains and the unemployment rate near a historical low.
Consumer price inflation—as measured by the 12-month percent change in the price index for personal consumption expenditures (PCE)—was still elevated in January.
Real gross domestic product (GDP) appeared to be expanding at a modest pace in the first quarter.
Although financial market data had shown reactions to developments in the banking sector late in the intermeeting period, there were essentially no economic data available that covered this period.
Total nonfarm payroll employment increased at a faster monthly pace in January and February than in the fourth quarter of last year.
The unemployment rate was little changed and stood at 3.6 percent in February.
Over the past two months, the unemployment rate for African Americans was unchanged, on net, and the unemployment rate for Hispanics moved up; the unemployment rates for both groups remained above the aggregate measure.
The aggregate measures of both the labor force participation rate and the employment-to-population ratio increased slightly.
The private-sector job openings rate in January—as measured by the Job Openings and Labor Turnover Survey—was little changed, on balance, since November and remained high.
Recent indicators of nominal wage growth had slowed but continued to be elevated.
In February, the 3-month change in average hourly earnings for all employees was at an annual rate of 3.6 percent, slower than its 12-month pace of 4.6 percent.
Over the four quarters of 2022, total labor compensation per hour in the business sector—as measured by the Productivity and Costs data—increased 4.5 percent, below its pace in the previous year.
Consumer price inflation remained elevated early in the year.
Total PCE price inflation was 5.4 percent over the 12 months ending in January, and core PCE price inflation—which excludes changes in consumer energy prices and many consumer food prices—was 4.7 percent.
The trimmed mean measure of 12-month PCE price inflation constructed by the Federal Reserve Bank of Dallas was 4.6 percent in January.
In February, the 12-month change in the consumer price index (CPI) was 6.0 percent, and core CPI inflation was 5.5 percent.
The CPI, along with data from the producer price index, pointed to some slowing in PCE price inflation in February.
The latest survey-based measures of longer-term inflation expectations from the University of Michigan Surveys of Consumers, the Survey of Professional Forecasters, and the Federal Reserve Bank of New York's Survey of Consumer Expectations remained within the range of their values reported in recent months, while near-term measures of inflation expectations from these surveys moved down.
Real GDP growth seemed to be expanding at a modest pace in the first quarter.
Gains in consumer spending had picked up in recent months, but growth in business fixed investment was slowing and residential investment was continuing to decline.
After contracting over the second half of last year, manufacturing output expanded moderately, on average, over January and February, but near-term indicators—such as national and regional indexes for new orders—pointed to softening factory output in the coming months.
The nominal U.S. international trade deficit registered a record high in 2022.
The trade deficit had been narrowing since March of last year but resumed widening in December and January.
Real goods imports rose in December and January, led by increases in imports of consumer goods and automotive products.
Real goods exports also increased, but by less than imports.
Indicators suggested that foreign economic growth rebounded in the first quarter of 2023 as China reopened rapidly from its COVID-19-related shutdowns and Europe's economy proved to be resilient to the energy price shock stemming from Russia's war against Ukraine and benefited from a mild winter that reduced energy demand.
Manufacturing activity in emerging Asia showed signs of a turnaround from its pronounced slowdown since mid-2022.
The recent developments in the banking sector led to some tightening of financial conditions abroad.
Oil prices edged down despite China's rapid reopening and the implementation of the European Union's embargo on Russian refined oil products.
Retail energy inflation continued to slow, contributing to an easing of headline consumer price inflation in many advanced foreign economies (AFEs). In contrast, core inflation has shown little sign of easing in most foreign economies amid tight labor markets.
In response, many foreign central banks continued their monetary policy tightening, although some have either paused or indicated that a pause soon was possible, citing the importance of assessing the cumulative effects of past policy rate increases.
Staff Review of the Financial Situation
Over the first several weeks of the intermeeting period, incoming economic data and FOMC communications appeared to refocus market participants on upside risks to inflation and policy rates, with the market-implied policy rate path steepening, nominal Treasury yields rising, near-term inflation compensation measures increasing, and broad stock market price indexes declining.
Financing conditions for businesses, households, and municipalities had tightened during this period and were moderately restrictive overall, as borrowing costs increased notably with the expected path of policy rates and Treasury yields and as some lenders appeared to tighten nonprice borrowing terms. Nonetheless, lending volumes were generally solid.
Credit quality was strong overall, although it had worsened a bit for some borrowers.
Expectations for future credit quality continued to deteriorate in some markets.
Pricing in financial markets changed notably in the latter part of the intermeeting period, amid developments in the banking sector.
Treasury yields and policy rate expectations moved down significantly, while broad stock price indexes rose somewhat.
The market-implied policy rate path shifted down sizably, with the federal funds rate expected to peak in May before decreasing afterward.
Further out, OIS (overnight index swap) quotes at the end of the intermeeting period indicated that the expected federal funds rate at year-end 2024 was 3.28 percent, about 50 basis points lower than before the closures of Silicon Valley Bank and Signature Bank but somewhat higher than at the time of the February FOMC meeting.
Treasury yields declined, especially at shorter maturities, reflecting downward revisions in policy rate expectations and the effects of flight to safety.
Inflation compensation declined, especially at short maturities, likely reflecting, in part, a relatively larger decline in risk premiums on nominal Treasury securities relative to Treasury Inflation-Protected Securities due to strong safe-haven demands.
Late in the intermeeting period, U.S. bank stock prices declined notably.
Regional banks with unusually large reliance on uninsured deposits and holdings of securities with significant unrealized mark-to-market losses experienced larger declines in stock prices.
Broad equity prices rose somewhat after the closures of Silicon Valley Bank and Signature Bank, reportedly driven by investors' reassessment of the outlook for interest rates, and after the announcement that UBS had agreed to buy Credit Suisse. The VIX—the one-month option-implied volatility on the S&P 500—increased to about 26.5 percent following the closures of Silicon Valley Bank and Signature Bank, but it subsequently declined to 21 percent—around the 70th percentile of its historical distribution.
Swaption-implied volatilities of short-term interest rates increased notably during this period, reflecting increased uncertainty about the interest rate outlook.
Some of the pricing moves in asset markets may have been amplified by impaired liquidity conditions.
Despite deteriorating liquidity conditions in Treasury, bond, and equity markets, market functioning remained orderly.
Over the intermeeting period, foreign financial markets were volatile as investors' focus shifted from resilience in economic activity and stubbornly high core inflation across advanced economies earlier in the period to stresses in the global banking sector more recently.
Earlier in the period, yields and market-based measures of inflation expectations in the AFEs increased notably, driven by spillovers from U.S. Treasury yields as well as upside surprises in economic and inflation data for AFEs.
Later in the period, developments in the banking sector led to large declines in advanced-economy yields, and, on net, AFE yields declined slightly.
Additionally, for the intermeeting period overall, the staff's dollar index rose moderately, corporate and emerging market economy sovereign credit spreads widened, and foreign equity indexes generally moved lower, with bank equities falling notably.
U.S. unsecured funding markets showed some signs of pressure later in the intermeeting period. Issuance of commercial paper (CP) and negotiable certificates of deposit (NCDs) dropped a touch over the entire period, and the fraction of CP issuance with overnight maturities increased but remained within normal ranges. Spreads of term CP and NCDs widened some, and spreads for issuers with lower credit ratings rose more, but other unsecured spreads remained within normal ranges. Prime MMFs experienced outflows, while government MMFs had inflows.
The effective federal funds rate was little changed after the closures of Silicon Valley Bank and Signature Bank.
Amid these developments, federal funds volumes initially declined sharply as the FHLBs reduced their activity in the federal funds market in order to meet increased demand for advances by member banks; market volume subsequently rebounded partially.
Activity in the repurchase agreement market was robust, and trading volume remained within recent ranges. ON RRP take-up remained within recent ranges as well.
Borrowing costs for businesses, households, and municipalities rose notably in the early part of the intermeeting period, mostly in line with increases in the federal funds rate and Treasury yields.
Since the closures of Silicon Valley Bank and Signature Bank, spreads on corporate bonds, municipal bonds, and leveraged loans rose, with speculative-grade corporate bond spreads registering the largest moves; spreads remained at moderate levels relative to their historical distributions.
Investment-grade corporate yields and municipal yields were down moderately, whereas speculative-grade corporate yields and leveraged loan yields were up modestly.
Mortgage rates were unchanged amid an increase in mortgage-backed securities (MBS) spreads.
Based on data that do not cover the period following the closures of Silicon Valley Bank and Signature Bank, nonprice terms and standards appeared to tighten somewhat in a number of markets.
Nevertheless, generally solid funding flows suggest that most firms and households had remained broadly able to access funding.
Data on credit conditions following the developments in the banking sector were limited.
After the two bank closures, issuance of municipal bond and leveraged loans was sluggish, and gross issuance of corporate bonds fell to near zero.
Mortgage loans to households remained available.
The credit quality of businesses and households was largely stable over the intermeeting period.
However, measures of credit performance showed some signs of weakening.
Leveraged loan credit quality deteriorated somewhat after the closures of Silicon Valley Bank and Signature Bank.
Credit quality for residential mortgages remained unchanged.
Fed officials were freaking out over the impact of banks and their stress on the economy in this meeting.
Given their assessment of the potential economic effects of the recent banking-sector developments, the staff's projection at the time of the March meeting included a mild recession starting later this year, with a recovery over the subsequent two years.