SVB collapse shakes expectations for US Federal Reserve interest rate decision

The much-anticipated March 22 Federal Reserve interest rate decision is just a week and a half away, and the drama that rocked the banking and financial sectors over the weekend is drastically shaking expectations for central bank results.

The Fed had been quick to raise interest rates to stem the most painful surge in inflation since the 1980s, raising interest rates to over 4.5 percent from almost zero a year earlier. Concerns about rapid inflation prompted the Fed to hike four consecutive three-quarter points last year before slowing to a half-point in December and a quarter-point in February.

Ahead of this weekend, investors had seen a sizable chance that the Fed would make a half-point hike at next week’s meeting. That move to the upside was seen as an option as job growth and consumer spending have shown surprising resilience to higher interest rates – prompting Fed Chair Jerome H. Powell to signal just last week that the Fed was planning a larger one step would consider.

But investors and economists no longer see that as likely.

In the past week alone, three big-name banks have failed as Fed rate hikes bounced through the tech sector and cryptocurrency markets, upending even normally legitimate banking models.

Regulators announced sweeping intervention Sunday night to prevent panic from spreading across the broader financial system. The Treasury Department, the Federal Deposit Insurance Corporation and the Fed said depositors at the failed banks would be repaid in full. The Fed announced drama emergency loan program that will help channel cash to banks that are facing heavy losses on their holdings due to the interest rate change.

The turmoil – and the associated risks for higher interest rates – should make the central bank more cautious in its move forward.

Investors have abruptly downgraded the number of rate moves they expect this year. After Mr Powell’s speech last week opened the door to a big rate hike at the next meeting, investors had sharply upgraded their forecasts for 2023, even factoring in a tiny chance that rates would rise above 6 percent this year. But after the wild weekend in finance, You see They see just a small move this month and expect the Fed to cut rates to just over 4.25 percent by the end of the year.

Economists at JP Morgan said the situation supports the case for a smaller quarter-point move this month. The economists at Goldman Sachs no longer expect interest rates to move at all. While Goldman analysts still expect the Fed to hike rates above 5.25 percent, writing Sunday night they see “significant uncertainty about the way forward.”

This moment poses a major challenge for the Fed: it is responsible for fostering stable inflation, which is why it has been raising interest rates to slow spending and business expansion in hopes of containing growth and cooling price increases. However, it also has the task of maintaining the stability of the financial system.

As higher interest rates can expose weaknesses in the financial system – as demonstrated by Friday’s Silicon Valley bank explosion and the huge risks facing the rest of the banking sector – these goals may conflict.

Subadra Rajappa, head of US interest rate strategy at Societe Generale, said Sunday afternoon that she thinks the evolving banking situation is a warning of rapid and drastic rate hikes – and said the instability in the banking sector is hampering the work of the central bank “more difficult,” forcing him to balance the two jobs.

“On the one hand, they have to raise interest rates: that’s the only tool at their disposal,” she said. On the other hand, “it will reveal the weakness of the system”.

Ms. Rajappa likened it to the old adage about the beach at low tide: “You’ll see who’s been swimming naked when the tide recedes.”