The Fed is poised to raise interest rates next week despite turmoil

Even with turmoil in the banking industry and uncertainty ahead, the Federal Reserve is likely to approve a quarter-percentage-point rate hike next week, according to market prices and many Wall Street experts.

Interest rate expectations have been on a rapidly swinging pendulum over the past two weeks, ranging from a half-point increase to holding the line and even at one point talk that the Fed could cut rates.

However, a consensus has emerged that Fed Chairman Jerome Powell and his colleagues in the central banks would like to signal that, although they are prepared for the upheaval in the financial sector, it is important to continue the fight to bring inflation down.

That is likely to take the form of a 0.25 percentage point, or 25 basis point, hike, accompanied by assurances that there is no predetermined path ahead.

“They have to do something or they lose credibility,” said Doug Roberts, founder and investment strategist at Channel Capital Research. “They’re going to do 25, and the 25 sends a message. But it’s really going to depend on the comments afterwards, what Powell says publicly… I don’t think he’s going to do the 180-degree shift that everybody’s talking about. “

Markets largely agree that the Fed will hike.

As of Friday afternoon, there was about a 75% chance of a quarter-point gain, according to CME Group data, which uses fed funds futures contracts as a guide. The other 25% were in the no-hike camp, anticipating that policymakers could back off from the aggressive austerity campaign that began just over a year ago.

Goldman Sachs is one of the most high-profile forecasters who sees no change in interest rates as it expects central bankers to generally “take a more cautious short-term stance to avoid exacerbating market fears of further banking stress.”

Whichever path the Fed takes, it will likely face criticism.

“This may be one of those times where there is a gap between what they should do and what I think they will do. They absolutely should not tighten policy,” said Mark Zandi, chief economist at Moody’s Analytics. “People are really on edge and any little thing can push them over the edge, so I just don’t get it. Why can’t you just pivot a little bit here and focus on financial stability?”

A rate hike would come just over a week after other regulators rolled out an emergency lending facility to stem a crisis of confidence in the banking sector.

The closings of Silicon Valley Bank and Signature Bank, along with news of instability elsewhere, rattled financial markets and fueled fears of more to come.

Zandi, who has predicted no rate hike, said it is highly unusual and dangerous to see monetary policy tightening under these conditions.

“You’re not going to lose your fight against inflation with a break here. But you could lose the financial system,” he said. “So I just don’t understand the logic of tightening policy in the current environment.”

Still, most of Wall Street believes the Fed will continue with its policy direction.

In fact, Bank of America said the policy moves from last Sunday to withhold depositors’ cash and shore up banks with liquidity give the Fed the flexibility to hike.

“The recent market turbulence stemming from distress at several regional banks certainly calls for more caution, but the robust action by policymakers to trigger systemic risk exemptions … is likely to limit the fallout,” Bank of America economist Michael Gapen said in a client note . “That said, events remain fluid and other stress events could materialize between now and next Wednesday, prompting the Fed to pause its rate hike cycle.”

In fact, several bank failures over the weekend could once again throw politics for a loop.

An important caveat to market expectations is that traders do not believe further rate hikes will last. Current pricing indicates rate cuts ahead, putting the Fed’s benchmark fund rate in a target range of around 4% by year-end. An increase on Wednesday would put the range between 4.75%-5%.

Citigroup also expects a quarter-point hike because central banks “will return attention to the inflation battle, which is likely to require further increases in policy rates,” the firm said in a note.

However, the market hasn’t had the benefit of hearing from Fed speakers since the financial turmoil began, so it will be harder to gauge how officials feel about recent events and how they fit into the policy framework.

The main concern is that the Fed’s moves to stop inflation will eventually push the economy into at least a shallow recession. Zandi said an increase next week would increase those odds.

“I think more rational heads will prevail, but it is possible that they are so focused on inflation that they are willing to take their chances with the financial system,” he said. “I thought we could get through this period without a recession, but it required reasonably good policy from the Fed.

“If they raise interest rates, that qualifies as a mistake, and I would call it a serious mistake,” Zandi added. “Risks of recession will be significantly higher at that point.”