Something broke, but the Fed still expects to push rates higher

Federal Reserve Chairman Jerome Powell testifies during the Senate Committee on Banking, Housing and Urban Affairs’ hearing entitled “The Semiannual Monetary Policy Report to the Congress” Tuesday, March 7, 2023 at the Hart Building.

Tom Williams | Cq-roll Call, Inc. | Getty Images

When the Federal Reserve starts raising interest rates, it generally does so until something breaks, according to the collective wisdom of Wall Street.

With the second and third largest bank failures of all time on the books for the past few days and fears more to come, this seems to qualify as a major collapse and reason for the central bank to pull out.

related investment news

Economist Ed Hyman says it might be a good idea for the Fed to take a break from this financial shock


Not so fast.

Even after the failures of Silicon Valley Bank and Signature Bank in recent days that forced regulators to act, markets are still expecting the Fed to continue its anti-inflation efforts. Rising bond yields played a particularly important role in SVB’s demise as the bank faced around $16 billion in unrealized losses on held-to-maturity government bonds that had lost principal value due to higher interest rates.

Still, the dramatic events may not even technically qualify as something breaking in Wall Street’s collective consciousness.

“No, it doesn’t,” said Quincy Krosby, chief global strategist at LPL Financial. “Is that enough to qualify as the kind of break that would have the Fed pivot? The market as a whole doesn’t think so.”

While market prices were volatile on Monday, the bias was for the Fed to tighten further. Traders put an 85% chance of a 0.25 percentage point rate hike when the Federal Open Market Committee meets March 21-22 in Washington, DC an estimate by the CME Group. Last week, markets were expecting a 0.50 point move for a brief period after Fed Chair Jerome Powell indicated that the central bank was concerned about the recent hot inflation data.

Thinking about a pivot point

manage the message

Citigroup economist Andrew Hollenhorst said a pause — a term Fed officials generally don’t like — would now send the wrong message to the market.

The Fed has sought to brush up on its anti-inflation credentials after months of denying rising prices as nothing more than a “temporary” effect from the early days of the Covid pandemic. Powell has repeatedly said that the Fed will stay the course until it makes significant progress in bringing inflation down to its 2% target.

In fact, Citi expects the Fed to continue raising its benchmark interest rate to a target range of 5.5% to 5.75%, compared to the current 4.5% to 4.75% and well above the market rate of 4.75 % until 5 %.

“It is unlikely, in our view, that Fed officials will pause rate hikes at next week’s meeting,” Hollenhorst said in a note to clients. “This would invite markets and the public to assume that the Fed’s determination to fight inflation only extends to the point of creating bumps in financial markets or the real economy.”

Bank of America said it remains “vigilant” for signs the current banking crisis is spreading, a condition that could change the forecast.

“If the Fed manages to contain recent market volatility and shield the traditional banking sector, it should be able to continue its gradual pace of rate hikes until monetary policy is sufficiently tight,” said Michael Gapen, BofA’s chief US economist. towards customers. “Our monetary policy outlook is always data dependent; currently it also depends on tensions in financial markets.”

Powell has also stressed the importance of using data to determine the direction he wants to take policy.

The Fed will take its final look at inflation measures this week when the Labor Department releases its February CPI on Tuesday and its PPI counterpart on Wednesday. A New York Fed survey released on Monday showed that one-year inflation expectations fell during the month. Something broke, but the Fed still expects to push rates higher

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