A Fed Pause Could do More Harm After Banking Crisis: Morning Brief

(Yahoo!Finance) - The Federal Reserve’s two main aims are to promote stable prices and full employment. At least, those are the goals that are typically most discussed.

At times of financial system stress – like now – one of the central bank’s other jobs comes into focus: “Maintaining the stability of the financial system and containing systemic risk that may arise in financial markets.”

With the collapse of Silicon Valley Bank and Signature Bank, the forced marriage of UBS and Credit Suisse, and persistent questions around the viability of First Republic Bank, the Fed is once again confronted with the need to ensure financial system stability.

Last week, the European Central Bank had a similar conundrum: should it stand pat on rates in light of Credit Suisse’s distress and risk higher inflation? Or should it raise rates and risk the Swiss bank’s troubles spilling over into the broader financial system?

It chose the latter. And many economists think the Fed will do the same when it meets on Wednesday.

“Bottom line is we still have an inflation problem, and the Fed needs to continue to raise rates,” Paul Gruenwald, chief economist at S&P Global Ratings, told Yahoo Finance. “So, they’ve obviously got one eye on the financial sector, but we still think they’re going to go 25 basis points later this week. But the language should be sort of softer and slower.”

Market participants are coalescing around that view, with data as of Tuesday morning showing an 86% chance the Fed raises rates by 0.25% on Wednesday, according to the CME's Fed Watch Tool.

And if the Fed does defy these predictions and pause its rate-hiking cycle, that could trigger more concern.

If the Fed doesn’t raise rates, “that sends a bigger signal, then I would start to get more anxious,” said Michael Arone, Chief Investment Strategist, US SPDR Business at State Street Global Advisors, in an interview with Yahoo Finance. He’s expecting a quarter-point raise.

Beyond this week’s meeting, the outlook for rates gets more murky. After all, as TKer.co’s Sam Ro writes, in some ways what has happened recently with banks has actually helped the Fed, by potentially slowing economic growth and therefore inflation.

The danger there, of course, is the Fed continuing to hike in the face of that slowdown and heading into the proverbial hard landing. Concern over that outcome has ratcheted up to the point that the market has started to price in a small cut to rates by the June meeting.

Expect all of these predictions to be scrambled after the rate decision and Fed Chair Jerome Powell’s press conference on Wednesday.

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By Julie Hyman · Anchor

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