Ongoing turmoil in the US banking sector is fueling uncertainty about the Federal Reserve’s monetary policy path ahead of the central bank’s critical meeting this week.
The Fed is widely expected to enact a small hike to benchmark interest rates at the conclusion of its two-day meeting on Wednesday – a move that would signal the resolve of Fed Chair Jerome Powell and his colleagues to bring down lingering inflation.
However, the possibility of a Fed “pause” gathered steam in recent days as regional banks came under intense pressure following the sudden implosions of Silicon Valley Bank and Signature Bank of New York.
“I think it’s a very, very close call, so I wouldn’t be surprised if [the Fed] took a pause,” Roger Ferguson, the Fed’s former vice chair, said during a Monday morning appearance on CNBC.
“If they pause, they’re going to have to explain exactly what they’re seeing that is maybe giving them more concern, so I’m not sure that a pause is comforting at this stage, given where the system is,” Ferguson added.
"It's a very close call. I wouldn't be surprised if [the Fed] took a pause," says Fmr. @federalreserve Vice Chair Roger Ferguson. "If they pause, they would have to explain exactly what they are seeing that is giving them more concern. So I'm not sure a pause is comforting." pic.twitter.com/aXV03vjGUr
— Squawk Box (@SquawkCNBC) March 20, 2023
The trouble within the US banking sector is a fresh headache for Powell – who warned just days before the crisis began that the Fed would likely need to hike interest rates higher than expected to tame prices. Inflation ran at 6% in February – well above the Fed’s 2% target.
The federal funds rate is currently set at a range of 4.50% to 4.75%.
The Fed’s most recent “dot plot” projections released in December showed the rate peaking at 5.1% this year before tapering off to 3.1% by 2025.
The market was pricing in a 71.6% probability that the Fed will hike its benchmark interest rate by a quarter percentage point as of Monday morning, according to CME Group’s FedWatch tool.
Just 28.4% of investors see the Fed pausing their policy tightening campaign and leaving interest rates unchanged.
Lloyd Blankfein, the former CEO of Goldman Sachs, was among those who suggested the recent banking sector turmoil could cause the Fed to pause their hawkish campaign.
“I personally think it will be OK to stop here,” Blankfein said during a CNN appearance on Sunday. “This situation will act in a way that is similar to a rate rise in some ways.”
Rising interest rates played a key role in the collapse of SVB – which took a massive $1.8 billion loss on its bond holdings after facing a cash crunch that forced a fire sale of its $21 billion bold portfolio.
Experts have warned that other regional banks could face similar trouble in the near future.
The feds’ move to guarantee all deposits at Silicon Valley Bank and Signature Bank has done little to assuage US markets, which have showcased significant volatility over the last week.
Elsewhere, a $30 billion plan to rescue regional lender First Republic from collapse has met with criticism, including from billionaire hedge fund boss Bill Ackman, who warned it could fuel the risk of contagion.
Investors will be listening carefully for hints about the Fed’s policy path and the overall economy when Powell holds his press conference on Wednesday afternoon.