The Fed is preparing to raise interest rates by a quarter point next week, despite the turmoil

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

Jonathan Ernst | Reuters

Even with turmoil in the banking industry and uncertainty ahead, the Federal Reserve will likely agree to a quarter-percentage-point rate hike next week, according to market pricing and several Wall Street experts.

Interest rate expectations have been a rapidly swinging pendulum over the past two weeks, ranging from a half point hike to keeping the line and even at one point talk that the Fed might cut rates.

However, a consensus has emerged that Fed Chair Jerome Powell and his fellow central bankers will want to signal that while they agree with the financial sector’s turmoil, it is important to continue the fight to bring down inflation.

That would likely take the form of 0.25 percentage points, or 25 basis points, accompanied by assurances that there is no predetermined path.

“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 the 25, and the 25 sends messages. But it will really depend on the comments after that, what Powell says publicly… I don’t think he’s going to do the 180-degree turn that everybody’s talking about.”

The markets largely agree that the Fed will rise.

As of Friday afternoon, there was a 75% chance of a quarter-point increase, according to CME Group data Use federal funds futures contracts as a guide. The other 25% were in the no-hike camp, expecting policymakers to back away from the aggressive tightening campaign that began just over a year ago.

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Goldman Sachs is one of the more prominent forecasters who see no change in interest rates, expecting central bankers in general to “adopt a more cautious stance in the short term in order to avoid exacerbating market fears of further banking pressure.”

a matter of stability

Whichever way the Fed goes, it will likely face criticism.

“This may be one of those times when there’s a difference between what they should do and what I think they’re going to do. They definitely shouldn’t tighten policy,” said Mark Zandi, chief economist at Moody’s Analytics. “People are really stressed out, and any little thing can push them over the edge, so I just don’t get it. Why can’t you focus here for a little bit and focus on financial stability?”

The price increase may come a little over a week after other regulators Introducing an emergency lending facility to stem the crisis of confidence in the banking industry.

The closing 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, who was expecting no rate hike, said it was very unusual and dangerous to see monetary policy tighten under these circumstances.

“You will not lose your battle against inflation by stopping here. But you may lose the financial system,” he said. “So I don’t understand the logic to tighten policy in the current environment.”

However, most of Wall Street believes that the Fed will go ahead with its policy.

Cuts are still expected by the end of the year

In fact, Bank of America said that Policy moves last Sunday to shore up depositors’ cash and shore up cash-strapped banks allow the Fed flexibility to hike.

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Bank of America economist Michael Gapin said in a note to clients: “The recent market turmoil stemming from distress at several regional banks certainly warrants increased caution, but aggressive action by policymakers to trigger systemic risk exceptions … is likely to limit of repercussions.” “However, events remain volatile and further stress events could materialize between now and next Wednesday, prompting the Fed to pause the rate hike cycle.”

In fact, more bank failures over the weekend could put politics back in a loop.

One important caveat to market expectations is that traders do not believe that any further rate hikes will last. Current pricing indicates future rate cuts, which put the benchmark federal funds rate in a target range of around 4% by the end of the year. Wednesday’s increase would put the range between 4.75%-5%.

The company said in a note that Citigroup also expects a quarter-point rise, on the grounds that central banks will “return attention once again to combating inflation that is likely to require further interest rate increases.”

Even so, the market hasn’t benefited from hearing fed speakers since the financial turmoil began, so it will be difficult to gauge how officials feel about recent events and how they fit into the policy framework.

The bigger concern is that the Fed’s moves to stem inflation will eventually take the economy into at least a shallow recession. Zandi said a price hike next week would raise those possibilities.

“I think more rational presidents will prevail, but they’re probably so focused on inflation that they’re willing to take their chance with the financial system,” he said. “I thought we could make our way through this period without a recession, but that required some reasonably good policy by the Fed.

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“If they raise the rates, it is a huge mistake,” Zandi added. “The risk of a recession is going to go up dramatically at that point.”

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