Even with the banking sector turmoil and uncertainty ahead, the Federal Reserve will likely approve a quarter-percentage-point interest rate hike next week, according to market prices and many Wall experts. Street.

Rate expectations have been on a rapidly swinging pendulum over the past two weeks, ranging from a half point hike to holding the line and even at one point there was talk that the Fed might cut rate.

However, there was consensus that Fed Chairman Jerome Powell and his fellow central bankers will want to signal that, while mindful of financial sector turmoil, it is important to continue the fight to lower inflation.

This will likely take the form of an increase of 0.25 percentage points, or 25 basis points, along with the assurance that there is no set path to follow. The outlook could change depending on market behavior in the coming days, but it looks like the Fed is increasing.

US Federal Reserve Chairman Jerome Powell speaks to reporters after the Fed raised its interest rate target by a quarter of a percentage point, during a news conference at the Federal Reserve Building in Washington , on February 1, 2023.

Jonathan Ernest | Reuters

“They have to do something or they lose credibility,” said Doug Roberts, founder and chief investment strategist at Channel Capital Research. “They want to do 25, and 25 sends a message. But it will really depend on the comments after, what Powell says in public. … I don’t think he’s going to do the 180 degree turn that everyone is talking about . “

Markets largely agree that the Fed will rise.

On Friday afternoon, there was about a 75% chance of a quarter-point increase, according to CME Group Data using federal funds futures as a guide. The remaining 25% were in the upside ban camp, anticipating that policymakers might take a step back from the aggressive tightening campaign that began just over a year ago.

Goldman Sachs is one of the more prominent forecasters, seeing no change in rates, as it expects central bankers in general to “take a more cautious short-term stance in order to avoid worsening market fears of further banking strains.

A matter of stability

Whichever direction the Fed takes, it is likely to face criticism.

“Maybe this is one of those times where there’s a difference between what they should be doing and what I think they will be doing. They definitely shouldn’t be tightening their policy,” Mark Zandi said , chief economist at Moody’s Analytics. “People are really on edge, and the smallest thing could push them over the edge, so I just don’t get it. Why can’t you just pivot here a bit and focus on financial stability?”

A rate hike would come just over a week after other regulators set up an emergency loan facility to end a crisis of confidence in the banking sector.

The shutdown of Silicon Valley Bank and Signature Bank, along with news of instability elsewhere, has rattled financial markets and raised fears of more to come.

Zandi, which did not expect any rate hikes, said it was highly unusual and dangerous to see monetary policy tightening under these conditions.

“You’re not going to lose your battle against inflation with a pause here. But you could lose the financial system,” he said. “So I just don’t understand the logic of policy tightening in the current environment.”

Still, most of Wall Street thinks the Fed will continue its policy stance.

Cuts still expected by the end of the year

In fact, Bank of America said the the policy measures taken last Sunday to support depositors’ liquidity and support cash-strapped banks give the Fed the flexibility to increase.

“Recent market turmoil resulting from the distress of several regional banks certainly calls for more caution, but vigorous action by policymakers to trigger systemic risk exceptions…is likely to limit the fallout,” the economist said. of Bank of America, Michael Gapen, in a client note. “That said, events remain fluid and further stress events could materialize by next Wednesday, leading the Fed to pause its rate hike cycle.”

Indeed, more bank failures over the weekend could shake up politics again.

An important caveat to market expectations is that traders do not believe further rate hikes will hold. Current prices point to upcoming rate cuts, putting the Fed’s benchmark funds rate in a target range of around 4% by the end of the year. An increase on Wednesday would put the range between 4.75% and 5%.

Citigroup also expects a quarter-point hike, saying central banks will “return attention to fighting inflation, which will likely require further increases in policy rates,” the company said in a statement. a rating.

The market, however, hasn’t had the benefit of hearing Fed speakers since the financial turmoil began, so it will be harder to gauge how officials feel about the latest events and how they fit in. in the political framework.

The biggest concern is that the actions taken by the Fed to stop inflation will eventually drag the economy into at least a shallow recession. Zandi said a hike next week would increase those odds.

“I think more rational heads will prevail, but it’s possible they’re so focused on inflation that they’re willing to take a chance with the financial system,” he said. “I thought we could get through this period without a recession, but that required reasonably good policy from the Fed.

“If they raise rates, that’s considered a mistake, and I would say that’s a blatant mistake,” Zandi added. “The risks of recession will increase significantly at this point.”

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