Uncertainty Intensified As Fed Hiked Interest Rate

Traders and economists remained divided on whether the Federal Reserve would hike its benchmark policy rate on Wednesday, as further actions by the world’s major central banks to stop banking stresses and the fallout from the acquisition of Credit Suisse kept markets on edge.

The U.S. central bank started its two-day policy meeting on Tuesday as policymakers mulled whether still scorching inflation merits an interest rate rise or whether uncertainty in financial markets exceeds those concerns. The Fed’s current target range is 4.5%-4.75%.

“I don’t think the Fed has any good options here,” said Tim Duy, chief U.S. economist at SGH Macro Advisors. “The risk is allowing inflation to become even more embedded versus the risk of aggravating a broader banking crisis.”

Prices of Fed funds futures indicated a near 70% probability of a quarter-percentage point rate increase on Monday against about a 30% possibility of no change, a slight firming in expectations as opposed to the end of last week.

Market pricing had swung wildly over the past 10 days with investors going from anticipating a bigger half-point rate hike before banking stresses cropped up to at one point seeing rates unchanged. Among economists, those who forecast a quarter-point hike do so without ruling out the possibility for a pause.

The Fed normally likes to telegraph the expected outcome of its policy meetings in order not to rattle financial markets but the fast pace of events in the past 10 days, in which two U.S. regional banks collapsed and Credit Suisse was bailed out by larger rival UBS at the weekend, has inverted those norms.

On Sunday, the Fed, as part of a joint action, offered daily currency swaps to banks in the euro zone, Britain, Canada, Japan, and Switzerland in order to ease funding strains in global markets, although banks borrowed only token amounts on Monday. The Fed also has already created an emergency liquidity backstop for U.S. banks.

The tumult has happened during the central bank’s premeeting blackout period that hinders officials from providing public clarity on their assessment of the situation.

“Barring a catastrophic collapse of the banking sector between today and Wednesday — one that reverberates globally — they will be focused on developments in the economy, which currently supports more policy tightening,” said Rubeela Farooqi, chief U.S. economist at High Frequency Economics, who predicts a quarter percentage point rate hike.

She hinted at a string of recent economic data, including a key inflation report last week, that indicate inflationary pressures are far from mitigated, and expects the Fed this week to raise its median projection for the funds rate at year-end to 5.4% from 5.1% at December’s meeting.

Inflation, while off its highs, is still running at 5.4% by the Fed’s preferred measures, well above the 2% target rate.

The Fed has also been shown a template of sorts in recent days with the European Central Bank last Wednesday upholding a 50-basis point rate hike, judging it could firewall its monetary policy actions to combat high inflation from those needed to allay fears about financial stability.

Analysts at Goldman Sachs, however, forecast a pause at the meeting this week because of the current volatility and helped by a steep drop in near-term inflation expectations. The investment bank then expects three additional 25 basis point increases in May, June, and July, with the policy rate peaking in the 5.25-5.5% range.

“While policymakers have responded aggressively to shore up the financial system, markets appear to be less than fully convinced that efforts to support small and midsize banks will prove sufficient,” they wrote. “We think Fed officials will therefore share our view that stress in the banking system remains the most immediate concern for now.”

The interest rate was hiked by a further 0.25%.