The Federal Reserve is predicted to boost rates of interest Wednesday by 1 / 4 point, but it surely also faces the tough task of reassuring markets it may well stem a worse banking crisis.
Economists mostly expect the Fed will increase its fed funds goal rate range to 4.75% to five% on Wednesday afternoon, though some expect the central bank could pause its climbing as a result of concerns in regards to the banking system. Futures markets were pricing in a roughly 80% probability for a rate rise, as of Tuesday morning.
The central bank is contemplating using its rate of interest tools at the identical time it’s trying to appease markets and stop further bank runs. The fear is that rising rates could put further pressure on banking institutions and crimp lending further, hurting small businesses and other borrowers.
“The broader macro data shows some further tightening is warranted,” said Michael Gapen, chief U.S. economist at Bank of America. He said the Fed could have to clarify its double-barreled policy. “You might have to point out you’ll be able to walk and chew gum at the identical time, using your lender-of-last-resort powers to quell any fears about deposit flights at medium-sized banks.”
U.S. Federal Reserve Chair Jerome Powell addresses reporters after the Fed raised its goal rate of interest by 1 / 4 of a percentage point, during a news conference on the Federal Reserve Constructing in Washington, February 1, 2023.
Jonathan Ernst | Reuters
Federal regulators stepped in to ensure deposits on the failed Silicon Valley Bank and Signature Bank, they usually provided more favorable loans to banks for a period of up to at least one yr. The Fed joined with other global central banks Sunday to boost liquidity through the standing dollar swap system, after UBS agreed to purchase the embattled Credit Suisse.
Investors shall be on the lookout for assurances from Fed Chairman Jerome Powell that the central bank can contain the banking problems.
“We wish to realize it’s really about a number of idiosyncratic institutions and never a more pervasive problem with respect to the regional bank model,” said Gapen. “In these moments, the market must know you’re feeling you understand the issue and that you just’re willing and able to doing something about it. … I feel they’re exceptionally good at understanding where the pressure is that is driving it and how you can respond.”
A month of turmoil
Markets have been whipsawed within the last month, first by a hawkish-sounding Fed after which by fears of contagion within the banking system.
Fed officials begin their two-day meeting Tuesday. The event kicks off just two weeks after Powell warned a congressional committee that the Fed can have to hike rates even greater than expected due to its battle with inflation.
Those comments sent rates of interest soaring. A couple of days later, the sudden collapse of Silicon Valley Bank stunned markets, sending bond yields dramatically lower. Bond yields move opposite price. Expectations for Fed rate hikes also moved dramatically: What was expected to be a half-point hike two weeks ago is now up for debate at 1 / 4 point and even zero.
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The two-year Treasury yield is most sensitive to Fed policy.
Messaging is the important thing
Gapen expects Powell to clarify that the Fed is fighting inflation through its rate hikes but then also assure markets that the central bank can use other tools to preserve financial stability.
“Things going forward shall be done on a meeting-by-meeting basis. It can be data dependent,” Gapen said. “We’ll must see how the economy evolves. … We’ll must see how financial markets behave, how the economy responds.”
The Fed is scheduled to release its rate decision together with its recent economic projections at 2 p.m. ET Wednesday. Powell will speak at 2:30 p.m. ET.
The problem is they’ll change their forecast as much as Tuesday, but how does anyone know?
Diane Swonk
Chief economist at KPMG
Gapen expects the Fed’s forecasts could show it expects the next terminal rate, or end point for rate hikes, than it did in December. He said it could rise to a couple of level of 5.4% for 2023, from an earlier projection of 5.1%.
Jimmy Chang, chief investment officer at Rockefeller Global Family Office, said he expects the Fed to boost rates of interest by 1 / 4 point to instill confidence, but then signal it’s finished with rate hikes.
“I would not be surprised if we get a rally because historically at any time when the Fed stops climbing, going to that pause mode, the initial knee-jerk response from the stock market is a rally,” he said.
He said the Fed is not going to likely say it’ll pause, but its messaging may very well be interpreted that way.
“Now, on the minimum, they need to keep up this air of stability or of confidence,” Chang said. “I do not think they’ll do anything that might potentially roil the market. … Depending on their [projections], I feel the market will think that is the ultimate hike.”
Fed guidance may very well be up within the air
Diane Swonk, chief economist at KPMG, said she expects the Fed is more likely to pause its rate climbing due to economic uncertainty, and the incontrovertible fact that the contraction in bank lending shall be corresponding to a tightening of Fed policy.
She also doesn’t expect any guidance on future hikes for now, and Powell could stress the Fed is watching developments and the economic data.
“I do not think he can commit. I feel he has to maintain all options on the table and say we’ll do whatever is vital to advertise price stability and financial stability,” Swonk said. “We do have some sticky inflation. There are signs the economy is weakening.”
She also expects it should be difficult for the Fed to present its quarterly economic forecasts, because the issues facing the banks have created a lot uncertainty. Because it did through the Covid pandemic in March 2020, the Fed might temporarily suspend projections, Swonk said.
“I feel it’s a vital thing to have in mind that that is shifting the forecast in unknown ways. You don’t need to overpromise somehow,” she said. Swonk also expects the Fed to withhold its so-called dot plot, the chart on which it shows anonymous forecasts from Fed officials on the trail for rates of interest.
“The problem is they’ll change their forecast as much as Tuesday, but how does anyone know? You would like the Fed to look unified. You don’t need dissent,” said Swonk. “Literally, these dot plots may very well be changing by the day. Two weeks ago, we had a Fed chairman able to go 50 basis points.”
The impact of tighter financial conditions
The tightening of economic conditions alone could have the clout of a 1.5 percentage point hike in rates by the Fed, and that might lead to the central bank cutting rates later this yr, depending on the economy, Swonk said. The futures market is currently forecasting rather more aggressive rate cutting than economists are, with a full percentage point — or 4 quarter-point cuts — for this yr alone.
“In the event that they hike and say they are going to pause, the market might actually be okay with that. In the event that they do nothing, perhaps the market gets nervous that after two weeks of uncertainty the Fed’s backing off their inflation fight,” said Peter Boockvar, chief investment officer at Bleakley Financial Group. “Either way we still have a bumpy road ahead of us.”
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The Fed could also make a surprise move by stopping the runoff of securities from its balance sheet. As Treasurys and mortgages mature, the Fed not replaces them because it did during and after the pandemic to offer liquidity to financial markets. Gapen said changing the balance sheet runoff can be unexpected. During January and February, he said about $160 billion rolled off the balance sheet.
However the balance sheet recently increased again.
“The balance sheet went up by about $300 billion, but I feel the excellent news there’s most of that went to institutions which might be already known,” he said.