The Federal Reserve’s two-day interest rate meeting, which begins on Tuesday, is expected to be one of its most exciting in recent memory.
Will the Fed, in spite of the fallout from Silicon Valley Bank’s failure, stand by its promises to battle inflation and raise interest rates once more? Alternatively, in a time of banking system instability, will it put financial stability first?
Most economists and investors anticipate the central bank to increase its benchmark short-term rate by a quarter percentage point as the recent easing of financial industry stress. That would add another notch to the Fed’s aggressive rate-hiking drive while also giving a nod to the recent unrest by delaying the half-point increase markets were anticipating prior to the crisis.
Yet Kathy Bostjancic, Nationwide Mutual’s chief economist, notes that “it’s a close call.”
An further rate hike would bring the Fed’s total rate hikes this year to 412 points, which is the most in four decades. The frenzy has pushed up previously low rates for bank savings accounts while also dramatically raising consumer borrowing costs for mortgages, auto loans, and credit cards. It has also severely damaged the stock market.
According to Gregory Daco, chief economist of EY-Parthenon, “Fed Chair Powell and most policymakers do not want their legacy to be failure to bring inflation down to the 2% target.”
Nonetheless, a number of prominent economists predict that the Fed would proceed cautiously and hold off on raising interest rates, including Bostjancic and Goldman Sachs.
Authorities can take heed of the fact that the crisis “is going to hinder economic activity and inflation,” according to Bostjancic. We’re taking a break to evaluate the particular stresses on the financial sector.
The link between a single (quarter-point) rise and the future course of inflation is pretty thin, and the (Fed’s policymaking committee) can always hike at its next meeting just six weeks later, says Goldman economist David Mericle in a research note.
What rate forecasts has the Fed made?
New predictions for the economy and the fed funds rate are also anticipated from the Fed on Wednesday. Hence, Goldman predicts that policymakers would announce three additional quarter-point rate rises by July to a range of 5.25% to 5.5%, even if the central bank may decide to keep rates unchanged at a range of 4.5% to 4.75%. According to Barclays, the Fed will predict a high rate of 5% to 5.25%.
Either forecast would demonstrate the Fed’s continued commitment to raising rates to reduce inflation and its current cautionary posture. However, these projections fall short of the peak rate of 5.5% to 5.75% that markets had anticipated prior to SVB’s collapse.
But, according to Bostjancic, markets now tend to think that the crisis is worse than it appears and that the Fed will botch its rate hikes. They predict that the Fed will raise rates on Wednesday, take a break, and then lower rates three times beginning in July. They contend that the combination of banking instability, a weakening economy, and rate hikes will cause a recession to break out within a few months.
Usually, Fed officials give advance notice of their plans to avoid shocking the markets, but the SVB issue developed during a quiet period when they were prohibited from speaking to the media.
These are four arguments in favour of the Fed raising rates by a quarter point and four against.
Banking anxiety has subsided
When failing tech businesses started taking money out of Silicon Valley Bank for funding requirements, a crisis developed, requiring SVB to sell bonds that had lost value due to the Fed’s abrupt rate hikes. Other clients with deposits exceeding $250,000 that aren’t FDIC insured withdrew their money as a result of the bank’s capital losses.
First Republic Bank, which just acquired $30 billion in deposits from JPMorgan and other major banks, was threatened by similar bank runs that destroyed Signature Bank of New York and brought about its death. In the meantime, UBS bought a shaky Credit Suisse.
In order to guarantee that depositors at SVB, Signature, and maybe other banks that represent a risk to the financial system could access all of their money, the Fed and other regulators stated they would provide funding. They also introduced a lending facility so that other local banks could borrow money to pay for withdrawals made by depositors who were not insured.
Stocks of regional banks fell last week but partially recovered on Monday. Because their profiles resemble SVB’s, Barclays claims that only a small number of financial institutions are susceptible to problems similar to these. In other words, a substantial portion of their depositors lack insurance, and a sizable portion of their assets are held in bonds, the value of which has plummeted.
According to a note sent to customers by Barclays, “We currently see preliminary signs of stability.”
Both the economy and inflation are robust.
There were hints of slower employment and salary growth and lower inflation late last year. Yet, this year’s job gains were extremely strong early on, and inflation spiked in January and February. That prompted Powell to suggest that a half-point increase was likely before the crisis.
It’s difficult to argue that the Fed should take a break given the strength of the job market and the persistence of consumer inflation, according to Scott Anderson, chief economist at Bank of the West. Furthermore, the Fed’s reputation could suffer much more if it took a break following its recent aggressive rhetoric.
