Notwithstanding the banking industry’s turbulence and uncertainties, the Federal Reserve is expected to approve a quarter-point interest rate increase next week, according to market pricing and many Wall Street analysts.
Rate expectations have been on a quickly swinging pendulum over the last two weeks, ranging from a half-point boost to holding the line, and even some discussion of the Fed cutting rates at one time.
But, it has emerged that Fed Chairman Jerome Powell and his fellow central bankers will want to convey that, while they are aware of the financial sector’s turmoil, it is critical to continue the struggle to bring inflation down.
This is anticipated to be in the shape of a 0.25 percentage point, or 25 basis point, hike, followed by assurances that there is no predetermined path forward. The expectation may alter depending on market action in the following days, but the Fed is expected to raise rates.
“They must act or they will lose credibility,” said Doug Roberts, founder and chief investment strategist at Channel Capital Research. “They want to do 25, and the 25 sends a message. So it’s really going to come down to what Powell says in public after the fact. I don’t think he’ll make the 180-degree turn that everyone is predicting.”
Investors are almost unanimous in their belief that the Fed will raise interest rates.
According to CME Group data using Fed funds futures contracts as a benchmark, there was a 75% possibility of a quarter-point hike as of Friday afternoon. The remaining 25% were against hikes, expecting officials to back off from the aggressive tightening drive that began just over a year ago.
Goldman Sachs is one of the most prominent forecasts that believes rates will remain unchanged, predicting that central bankers will “take a more cautious short-term attitude in order to prevent aggravating market fears of future banking stress.”
A matter of stability
Whatever path the Fed takes, it will almost certainly encounter criticism.
“This could be one of those situations when what they should do differs from what I believe they will do. “Policy should not be tightened,” said Mark Zandi, chief economist of Moody’s Analytics. “People are really on edge, and any little thing may drive them over the brink, so I just don’t get it. Why can’t you just take a step back and concentrate on financial stability?”
A rate hike would come just over a week after other authorities launched an emergency lending facility to stem a banking industry confidence crisis.
The failures of Silicon Valley Bank and Signature Bank, combined with reports of instability elsewhere, shook financial markets and fueled worries of more to come.
According to Zandi, who has predicted no rate hikes, tightening monetary policy under these conditions is exceedingly rare and dangerous.
“You’re not going to lose the battle against inflation by pausing here. “But, you risk losing the banking system,” he warned. “Therefore I just don’t get the logic of tightening policy in this scenario.”
Yet, the majority of Wall Street believes the Fed will stick to the current policy course.
Cutbacks are still predicted by the end of the year.
Moreover, Bank of America stated that the Fed’s policy steps last Sunday to backstop depositor cash and support liquidity-strapped banks provide it the option to increase.
“The recent market instability caused by a trouble in numerous regional banks undoubtedly warrants greater caution,” Bank of America economist Michael Gapen wrote in a client note. “But, events remain fluid, and other stress factors could occur between now and next Wednesday, prompting the Fed to suspend its rate hike cycle.”
Moreover, more bank collapses over the weekend could throw policy into disarray once more.
One major caveat to market forecasts is that traders do not believe any additional rate hikes would be sustained. Current pricing suggests that the Fed’s benchmark funds rate will be dropped to roughly 4% by the end of the year. A hike on Wednesday would bring the range to 4.75%-5%.
Citigroup anticipates a quarter-point increase as well, arguing that central banks would “return emphasis to the inflation fight, which is likely to need future hikes in policy rates,” according to a report from the business.
But, because the market has not heard from Fed speakers since the financial crisis began, it will be more difficult to evaluate how officials feel about the newest events and how they fit into the policy framework.
The main risk is that the Fed’s efforts to curb inflation would eventually push the economy into at least a mild recession. A hike next week, according to Zandi, would increase those chances.
“I believe more logical heads will prevail, but it is possible that they are so concerned about inflation that they are willing to gamble with the financial system,” he said. “I thought we could make our way through this time without a recession, but it required some relatively excellent policymaking by the Fed.
“If they hike rates, that is a mistake, and it is an enormous mistake,” Zandi continued. “At that moment, the recession risks will skyrocket.”