BNY strategist John Velis says the March FOMC broadly matched expectations, with no rate change and minimal forward guidance, while markets swiftly repriced toward a more hawkish path. He highlights that the Middle East conflict and higher energy prices have driven inflation expectations up, leaving the Federal Reserve (Fed) on hold and making the future rate trajectory highly uncertain.

FOMC uncertainty and shifting expectations

"The March FOMC met our expectations, with no rate changes, no major changes to the Summary of Economic Projections, and little – if any – forward guidance to the future path for policy rates. None of this surprises us, although markets were quick to price in a more hawkish path for rates thereafter. This, too, shouldn’t be terribly surprising given the increase in inflation expectations due to higher energy (and other industrial materials prices) costs and a Fed that is clearly on hold for now."

"On February 27, the day before the start of the Middle East conflict, implied expectations from the OIS curve indicated around 60bp in cuts by December this year. As of this writing, just before the Monday open in the U.S., the market now sees nearly 18bp of tightening, essentially moving from two cuts to nearly a full hike by year end.

"While this repricing is understandable, we think the rate path is far from set in stone. The duration of the war and the increase in energy and other industrial materials prices are major unknowns. Just this morning, word of a U.S. standdown has moved markets for now."

"We feel at a loss to assign meaningful, high-conviction probabilities to any plausible scenario. However, another scenario would be for inflation to remain elevated or rise further, taking inflation expectations with it. In that scenario, with no changes in rates, the real policy rate, net of inflation, would actually be falling, preventing the Fed from cutting the nominal rate for the remainder of the year."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor.)