By Moody’s Analytics
The Federal Open Market Committee meeting this week was as highly anticipated as any in recent memory.
And that’s saying something given the turbulence of the past three years.
Fed policymakers face a fragile banking sector and stubbornly elevated inflation. The textbook remedies for these two problems are largely incompatible. This left the Fed’s moves anxiously awaited, since they would signal which of the two has priority. On that front, it was an impressive balancing act.
Policymakers again elected to hike the target range for the fed funds rate. The latest quarter-point increase pushes the upper bound to 5%. Moody’s Analytics expected a pause at this month’s meeting given the precarious state of the financial system.
In his post-meeting news conference Fed Chairman Jerome Powell said a pause was discussed. However, worrying intermeeting inflation and jobs data as well as the committee’s confidence in the soundness and resilience of the U.S. banking system led to a unanimous decision to continue raising rates.
To mitigate the concern of another rate hike after a large bank collapsed due to poorly managed interest rate risk, the FOMC’s post-meeting statement and Powell’s news conference focused on communicating confidence in the banking system. Also, a keenly watched statement about future rate hikes turned decidedly dovish.
Powell stressed where the two efforts overlapped. Central bankers raise borrowing rates to increase the cost of borrowing and slow the pace of credit creation. Blunt as it may be, this is the most effective tool at their disposal to weaken demand and slow inflation.
However, a high-profile bank failure or two can nudge things in the same direction. The current turmoil in the financial system will lead to some self- tightening. Households, businesses and banks are on edge and likely thinking twice about taking on or issuing new debt.
For this reason, the FOMC adjusted its earlier statement that the committee “anticipates that ongoing increases in the target range will be appropriate” to a softer “some additional policy firming may be appropriate.” Powell described the change from “ongoing increases” to “additional policy firming” leaves room to see the extent to which the banking crisis tightens financial conditions.
The banking crisis and the Fed’s response also called into question the possibility that the central bank may alter its quantitative tightening schedule. The Fed has been allowing $60 billion in U.S. Treasuries and $35 billion in mortgage backed securities to mature each month without reinvesting them. This acts to steadily shrink the Fed’s balance sheet by reducing commercial banks’ reserves, which has the desired effect of siphoning liquidity from the financial system.
Given the Fed and Treasury’s actions in response to the bank failures—establishing a new credit facility that swaps securities at attractive rates to lessen liquidity needs of banks, QT seems like a contradictory effort. A surge in borrowing from the Fed’s discount window last week is emblematic of this dissonance.
Yet policymakers opted to stick with their QT plans, even if the new credit facility and liquidity needs of banks work in the opposite direction in the near-term. This is because these efforts are designed to be short-lived.
Further, whereas rate hikes are more data dependent, Fed communication about its balance sheet represents longer-term guidance, and credibility rests on it not being deemed reactionary.
The FOMC released its latest Summary of Economic Projections. The SEP is released on a bi-meeting schedule and March’s guidance shows how the committee’s outlook has changed since December. Surprisingly, there were no meaningful shifts.
The median projection for the fed funds rate’s peak is 5.1%, unchanged from December. This leaves room for just one more quarter-point increase in the fed funds rate. Similarly, the latest projections show little change in policymakers’ unemployment rate forecast. The median projection pegged the unemployment rate at 4.6% in December and 4.5% in March, likely owed to the U.S. labor market’s ongoing strength.
State fiscal policy contributes to delays in tax filing
U.S. tax refunds have proceeded tepidly this month. As of March 10, the average refund was $2,972, down 11% from a year ago. This shortfall is attributable to the American Rescue Plan, which pumped up the average refund last year.
As we have written before, the ARP’s impact on refunds was limited to just the 2022 tax filing season. That said, the average refund this year is 0.8% above its typical amount at comparable points in the three years prior to the pandemic.
Therefore, it is not the average refund that is causing aggregate issuance to trail pre-pandemic norms, but rather the total number of refunds that are getting sent out to taxpayers.
Indeed, the total number of refunds was 49.2 million as of March 10, which is 20% less than its average at the same point in the three years before COVID-19. The IRS is receiving fewer tax returns and issuing fewer refunds as a result. It is possible that two years of delayed deadlines to file individual income tax returns may be causing taxpayers to file later than they were accustomed to prior to the pandemic.
In recent years, it has been fiscal policymaking at the federal level, from the Tax Cuts and Jobs Act of 2017 to federal pandemic relief legislation, that has created some confusion for taxpayers upon filing. This filing season, it is fiscal policy at the state level that has caused confusion and may be contributing to the observed delay in filing.
In early February, the IRS asked taxpayers in 21 states to hold off on filing as it worked with state tax authorities to determine the taxability of special payments those states issued to households last year. Shortly thereafter, the IRS provided guidance that taxpayers in most of these states would not need to include these payments in their 2022 tax returns.