The Federal Open Market Committee meets next week, at which time it is expected to raise its benchmark interest rate another 50 basis points, to a range of 4.75% to 5.00%, if we correctly interpret Fed Chair Jerome Powell’s testimony to Congress last week, when he said “the ultimate level of interest rates is likely to be higher than previously anticipated.”
Before that, the market had expected a 25-basis point increase, equivalent to its most recent hike at the Jan. 31-February 1 meeting. As we know, his comments sent stock and bond prices sharply lower.
Since then, though, we’ve had some serious news coming out of the banking system, namely the failure of SVB Bank and the closure of Silvergate Capital (both regulated by the Fed!) and worries that some of the largest U.S. banks (also regulated by the Fed) are sitting on some huge, unrealized losses in their government bond portfolios.
In this atmosphere, is a larger than expected rate increase next week—i.e., 50 bps rather than 25—justified?
Or should the Fed maybe show a little restraint and raise the fed funds rate only a quarter point?
And if it does, what will be the likely market reaction?
In his Capitol Hill testimony, Powell focused – as you would expect – on the U.S. economy, namely its stronger than expected recent performance, particularly in the jobs market, which in February gained another 311,000 jobs even as the unemployment rate rose slightly to 3.6%.
The Fed seems hellbent on making up for its past errors of overly long, overly loose monetary policy by ramming through rate increases no matter how much harm they might cause.
Ignoring the second component of its Congressional mandate, namely promoting full employment, the Fed is instead totally focused on slaying inflation as fast as possible, even though getting from the current rate of inflation – 6.4% in January — back down to its 2% target will no doubt take some time.
After all, the Fed only started raising interest rates back in March 2022, when the fed funds rate was at or near zero.
While getting the interest rate regime back to the “old normal” of 5-6% has been a long time coming and is a worthy endeavor, it’s probably unrealistic to believe we can get there in a year or so, after we’ve become accustomed to more than 15 years of near-zero rates, without causing some serious and unforeseen problems.
Since Powell has gone out of his way recently, most notably during his Congressional testimony, to disabuse the markets of the idea that the Fed is about to “pivot” to a more moderate rate-rising program, it’s unlikely that the Fed will do anything other than raise rates by 50 bps at its March 21-22 meeting.
But what if it doesn’t? What if concerns about potential problems in the banking system force the Fed to hold back and raise rates only 25 bps, or not at all?
The first reaction might be euphoria. Stocks will rally on the belief that the Fed is doing the right thing by moderating its rate-hiking regime.
Conversely, such a move might create a whole new reason to worry. What does the Fed know that we don’t? Are things so bad out there that the Fed doesn’t dare change rates more than it’s conditioned us to expect?
I think the latter reaction is least likely, for the simple reason that the Fed, despite all its collective brain power, really doesn’t know more than us mere mortals do, certainly a lot less than we give it credit for (see SVB and Silvergate, which happened right under its nose).
In his testimony, Powell didn’t mention any potential problems in the banking system, which didn’t come to light until a couple of days later.
Is that because he didn’t want to create a panic, or because the Fed doesn’t believe these potential problems aren’t as serious as the market reaction implied?
It’s hard to believe he didn’t know of their existence, since Fed officials talk with the nation’s most important bankers all the time. How could he not know? Then again…
If I had to bet, I would expect the Fed to go through with a 50 bp hike next week, barring some new, Black Swan-type, calamity, since it’s already pretty much telegraphed that’s what it’s going to do.
But the Fed should also say it is closely monitoring the banking sector and any potential economic fallout, which could require a more moderate policy stance going forward.
Disclosure: This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.
This post was originally published on INO.com