Proactive Investors - At the start of the week, the US Federal Reserve was widely expected to raise interest rates by another 50 basis points (bp) at its next meeting in a bid to tame inflation.
Earlier this month, Fed chair Jerome Powell told lawmakers that interest rate hikes will likely be higher and faster than previously expected.
"The latest economic data have come in stronger than expected, which suggests that the ultimate level of interest rates is likely to be higher than previously anticipated," Powell said in prepared remarks for a hearing before the Senate Banking Committee.
"If the totality of the data were to indicate that faster tightening is warranted, we would be prepared to increase the pace of rate hikes."
That was before the turmoil in the financial sector caused by the collapse of Silicon Valley Bank (SVB), however.
Just days after Powell’s hawkish comments to US Congress, troubles at SVB prompted fears of contagion and turmoil.
That led to a collapse in rate hike expectations for the next FOMC meeting, scheduled for March 22.
“From pricing 100bp of cumulative hikes, we were looking at a potential 75bp of cuts by the end of the summer at one point,” ING analysts commented Friday.
“For a long time, we have been on the more dovish end of expectations for interest rate moves in 2023. The concern was that this has been the most aggressive monetary policy tightening cycle for 40 years and by going harder and faster into restrictive territory you naturally have less control over the outcome. In such an environment we need to be alive to the risk of economic and/or financial stress and Silicon Valley Bank is a clear example of this.”
Don't rule out possibility of 50bp
SVB and the failure of Signature Bank could be viewed as special cases but Credit Suisse’s woes are intensifying the nervousness that is rippling through the industry, the analysts added.
A 25bp is the most likely outcome, according to ING. That said, the muted market reaction to the European Central Bank’s decision this week to raise rates by 50bps suggests that a similar move by the Fed is still on the table, analysts noted.
A surprise rate cut, as predicted by one bank, would signal major concern at the Federal Reserve, which could in turn mean financial market worries turn into a panic that exacerbates recession risks.
So it will likely be a 25bp move or no change on March 22.
“The most prudent course of action, in our view, would be to pause to assess the damage, but leave the door open to a potential restart if the fallout is limited and inflation concerns persist,” ING analysts noted.
“However, it is those inflation concerns that mean the Fed retains a desire to get the policy rate higher, should conditions allow.
“We also suspect the Fed will want to express confidence in the financial system and one way to do this would be to hike 25bp and signal in their forecasts that they think the Fed funds rate will end the year higher than it currently is.”