How Will Banking Dynamic Affect Fed’s Decision?

Jeremy Siegel

March 20, 2023

Jeremy J. Siegel, WisdomTree’s Senior Investment Strategy Advisor, is the Russell E. Palmer Professor Emeritus of Finance at The Wharton School of the University of Pennsylvania. Professor Siegel has written and lectured extensively about the economy and financial markets and is a regular contributor to the financial news media. In 1994, he received the highest teaching rating in a ranking of business school professors conducted by BusinessWeek magazine. His book, Stocks for the Long Run, was named by The Washington Post as one of the 10 best investment books of all time. His latest book, The Future for Investors, is a bestseller.

This week we have the important Federal Reserve meeting on Wednesday, and I expect, barring increased turmoil, that the Federal Reserve will hike rates 25 basis points. I believe this hike will be accompanied by a hint in the press conference to pause at the next meeting. The Fed will never commit entirely to a pause and claim to be data dependent, but I believe they will steer our expectations to the pause.

This Fed meeting brings with it the release of the Dot Plot (a statement of economic projections) at 2:00 p.m. Eastern Time. These Dots are filled in ahead of the meeting and I do not know if the participants will have a chance to revise their expectations ahead of the release based on the latest banking failures.

I can see a scenario where the Dot Plot visuals read out with hawkish headlines and the market sells off in the very short-term after the 2:00 p.m. release. This type of very short-term prediction is fraught with error and uncertainty, but I am giving you my feeling of what might occur on the Fed release. Powell will then likely talk down expectations for future rate hikes at the press conference and give relief back to the markets.

Could Powell pivot to a pause at this meeting and not hike at all? Some believe the current banking stress will lead to a rapid tightening in credit standards as a substitute for further rate hikes and should cause Powell to pause now. Torsten Slok, Chief Economist at Apollo, wrote on Saturday that his team estimated that tighter financial conditions over the last week could translate to a 1.5% increase in the Fed Funds Rate—or 6 more 25 basis point hikes!

Yet, there is some psychological messaging impact here from Powell too. If the Fed foregoes a rate hike, it signals the Fed is very worried about this banking dynamic to ‘give up’ on the inflation fight—when just a week ago there was a sense the Fed might hike 50 basis points because it was so concerned about the strength of the economy and underlying inflation pressure.

In summary, the Fed’s hawkishness will be toned down and they will discuss monitoring the fallout of the banking panic closely.

I reiterate we need to have temporary insurance of all deposits everywhere until we can reform the entire deposit system. All payroll accounts need to have full insurance. We need protection from fraudulent loans that create deposits, but in general, we need much higher deposit protection, so these bank runs do not occur.

I believe the FDIC has not lost a penny in 40 years. Or if it did, it was extremely minor, and many times made over by the fees banks pay to the FDIC. There are talks to increase insurance coverage, banks may be charged an extra 10 basis points or so of fees. This increase is tiny when deposits are paying 1% interest and the competitive market rate is 5%—consumers are effectively being charged 400 basis points and most should be little worried about a 10-basis point fee to have higher insurance limits.

I also remind people when interest rates were zero, banks still found a way to make money. So, banks should be passing along more of these rate increases to their consumers.

Is there going to be a recession? The claims data once again came in strong. Housing starts came in strong. There was a slowdown in some manufacturing gauges and the Philadelphia Fed Manufacturing Index, and much of this was prior to the bank failures.

We did get University of Michigan Consumer Sentiment Index numbers last week. They were very good on inflationary expectations, which again gives the Fed further rationale to downshift rate hikes. Furthermore, the Producer Price Index (PPI) came in much lower than expected, with revisions to prior data also showing a softening of inflation.

I maintain the $220 earnings estimate for the S&P 500 may be conservative for 2023. Financials make up the second largest contributor to earnings and S&P shows more than 16% of total $220 profit estimate comes from the financial sector. That may be the greatest risk for earnings disappointments, but we are seeing more companies attempt to protect earnings and margins either with price hikes or cost reduction programs.

The recent turmoil in markets also makes me more optimistic on the outlook for 2024. If this banking accident occurred later, we would have much higher rates. So, a natural downshift in how tight policy will become from this is one of silver linings from this current banking crisis.

I want the Fed to get back to growing the money supply at a 5% level that is consistent with 2% inflation and 2-3% real growth in the economy. When you have the money supply shrinking over the last 12 months as we do now, that is a problem for liquidity.

Bitcoin is enjoying it biggest rally in a long time. Bitcoin was launched with a mantra that the banking system was terrible, and the economy needed an alternative. So, the narrative is helping drive money into bitcoin with a 30% gain in the last week. My feeling is when people feel they’re safe in the banks again, bitcoin will go back down. But in the meantime, it’s certainly enjoying a story that was put in hibernation for the last 6-9 months.

Past performance is not indicative of future results. You cannot invest in an index.

Professor Jeremy Siegel is a Senior Investment Strategy Advisor to WisdomTree Investments, Inc. and WisdomTree Asset Management, Inc. This material contains the current research and opinions of Professor Siegel, which are subject to change, and should not be considered or interpreted as a recommendation to participate in any particular trading strategy, or deemed to be an offer or sale of any investment product and it should not be relied on as such. The user of this information assumes the entire risk of any use made of the information provided herein. Unless expressly stated otherwise the opinions, interpretations or findings expressed herein do not necessarily represent the views of WisdomTree or any of its affiliates.

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