‘Fireman and policeman’: Fed faces rate hike dilemma amid bank turmoil

The US Federal Reserve is set to make one of the biggest decisions of its rate hike campaign this week as it considers whether to push for another hike, unsure if efforts to strengthen the banking sector will work in the long term.

Central bank officials will convene on Tuesday for their final two-day meeting to decide whether to move forward with another quarter-point rate hike or abandon the hike.

The dilemma arises as world authorities acted quickly to prop up the financial system after the collapse of the Silicon Valley bank, with fed deploying a new facility to bail out creditors and mediating the Swiss government’s hasty takeover of the indecisive Credit Suisse by UBS.

However, it remains unclear whether these actions will be enough to stop the effects of the crisis. Share prices of most US regional banks fall well below pre-crash levels SVBwhile shares of First Republican Bank are still plummeting after a second downgrade of its credit rating on Sunday.

As a result, the Fed is somewhat blind in deciding whether to put a stop to its aggressive campaign to rein in sustained inflation to help stabilize the financial system.

“This is an extremely challenging time,” said Ellen Meade, who served as a senior advisor on the central bank’s board of governors until 2021. [Fed chair Jay] Powell should be both a fireman and a policeman.”

Further complicating the high-stakes decision, due on Wednesday, is that it will be accompanied by fresh forecasts not only for the trajectory of interest rates, but also for growth, inflation and unemployment at a time when the economic landscape is rapidly changing.

“The whole thing is a disinflationary event. . . but at this point it’s very hard to see how disinflationary that is,” said Ian Shepherdson, chief economist at Pantheon Macroeconomics, referring to the banking turmoil.

Fueling the uncertainty is the fact that regional banks are expected to cut lending sharply in response to recent rulings. Torsten Slok, chief economist at Apollo Global Management, believes that banks, which own about 40 percent of all assets in the sector, could cut spending, leading to a sharp recession this year.

“What we do know is that the combination of delayed effects of monetary policy slowing things down and now ramping them up with this downside risk is only making things worse,” he said.

Slok estimates that the combination of tighter financial conditions and lending standards following the recent bank failures has effectively raised the federal funds rate — the rate at which banks lend to each other — by 1.5 percentage points from the current target range of 4.5 to 4.5 percentage points. .75 percent. percent.

As a result, he now expects the Fed to pull back on Wednesday’s rate hike. Economists at Goldman Sachs, who are also forecasting a pause this week, are forecasting an equivalent federal funds rate hike of about a quarter or half a point after recent events. Other economists argue that it is too early to make an accurate estimate.

A complete suspension of the interest rate campaign would mean a sharp reversal for the central bank, which this month lifted perspective accelerating the rate of increase in pace with a half point increase after moving last month to a more typical frequency of a quarter point.

In his speech to Congress ahead of the release of the February employment and inflation data, Powell said the decision would depend in part on these closely watched data, none of which showed much sign of a cooling economy. He also said the Fed would eventually need to raise its base rate above the 5.1 percent that officials had projected back in December.

Since then, most economists have revised their expectations for the so-called scatter plot, which aggregates individual forecasts for federal funds rates through 2025.

Before the collapse of the SVB, many thought that the median valuation of the so-called terminal rate would rise by half a percentage point to 5.5-5.75%. Now some are predicting that this will remain unchanged, while others expect only a quarter point increase.

Traders in the federal funds futures markets are even more hesitant, assuming the Fed will only raise rates by another quarter of a percentage point before changing course and introducing cuts.

“The Fed still has some work to do,” said Vincent Reinhart, who has worked at the U.S. central bank for more than two decades and now works for Dreyfus and Mellon, although he says officials are “less sure where they’re on their way.”

Economists questioned The latest Financial Times survey, in partnership with the Global Markets Initiative at the University of Chicago’s Booth School of Business, says recent events have forced them to lower their expectations for the federal funds rate at the end of the year by a quarter of a percentage point. However, most still believe that the Fed will raise the rate to at least 5.5% and keep it at that level until 2024.

Reinhart warned that if the Fed paused its rate hike in an attempt to shore up financial stability, especially as economic data calls for further tightening, it would face increased criticism for failing to manage the banking sector sufficiently to prevent such a problem in the first place.

What’s more, Mead warned that such a move could cast doubt on Powell’s commitment to fighting inflation, adding that she supported a quarter-point hike.

“It preserves the notion of trust that he has worked hard to rebuild over the past year,” she said. “I don’t think he’s going to want to let it go at this point.”