Is this the Fed's last hike?

The Federal Deposit Insurance Corporation seized First Republic Bank in the early hours of 1 May and sold most of its assets and deposits to JPMorgan Chase straight away. It was an orderly, government-arranged end to the second-largest bank failure in American history. Two days later Jerome Powell's Federal Open Market Committee raised the federal funds rate by another 25 basis points, to a target range of 5.00 to 5.25 per cent. The more telling change was in the committee's statement. The line anticipating that "additional policy firming may be appropriate" had been cut out.

Deleting that one sentence of forward guidance probably marks the end of the fastest tightening campaign since Paul Volcker ran the Fed. Over 500 basis points of cumulative increases, the central bank has taken its policy rate from zero to the highest level in sixteen years.

Ten rises in fourteen months

The campaign began in March 2022 with a quarter-point move and quickened through the summer, when the committee raised rates by three-quarters of a point at four meetings in a row. It slowed to half a point in December and to quarter-point steps this year. The move in May was the tenth consecutive increase.

The committee's own projections, published in March, showed a median peak of 5.1 per cent for this year. The new range, with a midpoint just above that, is where officials said they expected to stop, so the change in wording confirms a plan more than it announces a new one.

A pause, with conditions

Without the tightening language, the committee has moved into a conditional pause. Its members want to watch how their earlier increases work through the economy, especially the credit squeeze now spreading through regional banks.

Mr Powell was careful at his press conference to say that a pause is no pivot. The Fed has no plans to cut. It intends to hold the rate at 5.25 per cent and let real interest rates rise as inflation slows.

Banks do some of the work

The failures of Silicon Valley Bank, Signature and now First Republic have done part of the Fed's job for it. Banks that have lost deposits, or fear they might, lend less and demand more from borrowers, and Mr Powell has argued since March that tighter credit could substitute for some further rate rises. Small and mid-sized banks provide a large share of lending to smaller businesses and commercial property, so the squeeze falls hardest where the Fed's rate rises had so far bitten least.

How much tightening the banking stress is worth is hard to measure. The Fed's survey of senior loan officers, due next week, will give the first systematic reading since the failures began.

No cuts on the horizon

Equity investors cheering the last rate rise are cheering the first cut too early. Core inflation is still stuck uncomfortably above 5 per cent, and the labour market is still adding hundreds of thousands of jobs. Cutting rates now would risk a second wave of inflation, which the Fed will not entertain.

The figures bear that out. Core consumer prices rose 5.6 per cent in the year to March, and payrolls grew by 236,000 in the same month, with unemployment at 3.5 per cent. Job openings have fallen below ten million for the first time since 2021, a sign the labour market is cooling, but not yet at a pace that would bring inflation back to 2 per cent quickly. Futures markets nonetheless price rate cuts before the end of the year.

A long hold at this level moves income from borrowers to savers. Money market funds now pay savers more than at any time since before the financial crisis, while companies with floating-rate loans and owners of commercial property who must refinance carry the cost. Regional banks sit on both sides of that divide, paying more to keep deposits while their borrowers struggle to service loans. The longer rates stay put, the more of that strain turns into defaults.

What 2006 suggests

The closest precedent has the same number in it. The Fed stopped raising rates at 5.25 per cent in June 2006 and held them there for more than a year, cutting only in September 2007 when the housing bust began to spread through credit markets. In 1995, by contrast, the Fed cut within five months of its last increase, because inflation was already low and the economy had slowed sharply.

Today's inflation looks more like the first case than the second. The 1995 cut was possible because inflation sat near the Fed's comfort zone. In 2006 core inflation was running above that zone, and the Fed chose to wait. With core inflation more than twice the target now, the argument for waiting is stronger still.

What would force a move

The case for an early cut rests on something breaking. A sharper run on regional banks, a disorderly fight over the debt ceiling, which the Treasury says could leave it short of cash as early as June, or a sudden rise in unemployment could all force the Fed's hand. Short of that, the committee has told markets it will be guided by the data, and the data have not yet given it reason to ease.

The bar for further increases is now high. The bar for cuts is higher still. The Fed has probably reached its peak at 5.25 per cent. Investors who think the pain ends with the last hike will find that sitting at a restrictive rate through the rest of the year hurts about as much as getting there did.