Decision Day

Macro Markets

FOMC 

The Federal Reserve is expected to raise interest rates Wednesday by a quarter point, but it also faces the tough task of reassuring markets it can stem a worse banking crisis. Economists mostly expect the Fed will increase its fed funds target rate range to 4.75% to 5% on Wednesday afternoon, though some expect the central bank could pause its hiking due to concerns about the banking system. Futures markets were pricing in a roughly 80% chance for a rate rise as of Tuesday morning.

The base case market is pricing in at the moment a 25bp hike and then a dovish stance by Fed Governor Powell. A rate increase would add to the 4.5% hikes this past year, which is the most in over forty years. This has resulted in tightening financial conditions like borrowing costs of mortgages, loans, and credit cards and has hit all risk markets across the board. This has also resulted in a huge issue with the banking sector that was holding its assets in US bonds which had the worst-performing year in history in 2022.

Bets on the Federal Reserve’s next move have been all over the place the past month, from increased expectations of a 50-basis point hike to no hike at all. Now we are back to a majority view that the Fed increases benchmark interest rates by 25 basis points when it's Federal Open Market Committee (FOMC) meets this week. According to a new CNBC Fed Survey, if the latest view turns out to have twisted and turned its way to be correct, it’s not because the market is convinced a hike is the right move for the Fed. Almost three-quarters of respondents (72%) expect the Fed to hike by one-quarter of a percentage point, according to the survey, but only 52% say the Fed should hike. On Tuesday morning, the CME FedWatch finds the market pushing up bets on a 25 basis point hike to over 81% (it had been 74% on Monday).

Why will the Fed go 25bps?

The crisis occurred when struggling tech companies began withdrawing their money from Silicon Valley Bank for funding needs, forcing SVB to sell bonds that had declined in value because of the Fed’s sharp rate hikes. The bank’s capital losses led additional customers whose deposits of over $250,000 aren’t FDIC insured to withdraw their money. Similar bank runs led to the demise of Signature Bank of New York and threatened First Republic Bank, which recently received $30 billion in deposits from JPMorgan and other major banks. Meanwhile, UBS purchased a teetering Credit Suisse.

The Fed and other regulators announced they would provide funding to ensure depositors at SVB, Signature, and possibly other banks that pose a risk to the financial system could access all their money. They also unveiled a lending facility so other regional banks could borrow money to cover withdrawals by uninsured depositors.

Regulators have taken pains to ensure the banking system is stable. If the Fed shows panic and doesn’t hike, it would show that things are worse than expected and we could see a bigger run on regional banks. It is important to show that they will do whatever it takes to curtail the banking crisis while at the same time doing their job to fight inflation. They can, however, choose to slow down or pause hikes after this to let their work do the job, which the market will take as a fair and less volatile sign.