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, “It’s a close call,” says Kathy Bostjancic, chief economist of Nationwide Mutual.
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.
“Fed Chair Powell and most policymakers do not want their legacy to be failure to drive inflation down to the 2% objective,” Gregory Daco, chief economist of EY-Parthenon, wrote in a note to clients.
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.