Expectations are high that the Federal Reserve will raise interest rates by a quarter point next week, but the central bank could still change policy quickly if the financial system becomes stressed. After a torrid run, federal funds futures on Thursday reflected more than an 80% chance that the central bank would raise rates by 25 basis points next Wednesday. One basis point is equal to 0.01 percentage point. Ethan Harris, head of global economic research at Bank of America, said the company expects the Fed to hike a quarter point, but the central bank could change course if necessary. “We have the Fed making three 25 basis point hikes, including next week,” he said. “That’s assuming regulatory efforts to support the banking system are effective and additional negative news is limited, so the Fed can focus on inflation again. That’s a tight call for the week. next because it really depends on what the markets do when the Fed meets.” Stocks closed higher on Thursday as regional bank stocks climbed. Treasury yields also rose as investors learned that a A consortium of 11 banks had agreed to deposit $30 billion in First Republic Bank. Participating institutions include JPMorgan, Citigroup, PNC and Truist. Earlier, the European Central Bank had raised rates by half a point. Concerns over the health of Credit Suisse also eased after the Swiss National Bank said on Wednesday that the bank was well capitalized and would provide it cash if necessary. A fluid situation Worries about banking contagion following the failure of Silicon Valley Bank pushed buyers into Treasuries and pounded risky assets, such as stocks and oil. The 2-year Treasury yield has traded with wide swings since then. The yield, which best reflects Fed policy, rose to 4.17% at the end of Thursday’s session, from a low below 3.9% in the morning. Yields move opposite the price. Market odds for a Federal Reserve rate hike rose sharply on Thursday, from 50% on Wednesday. Those expectations have shifted wildly. They were at 50% after big swings on Wednesday, but there were also traders expecting a half-percentage-point rise ahead of the Silicon Valley Bank bankruptcy. As the news broke on First Republic, the odds were at one point above 85% on Thursday afternoon before falling back to closer to 80%. Economists have differing views on how the central bank will react to recent US bank failures and concerns over Credit Suisse. JPMorgan economists expect the Fed to hike rates next week and again in May. But Goldman Sachs economists said they believe policymakers will hold off on a hike. Moody’s Analytics expects no rate hikes and anticipates that the Fed may signal that it is done with hikes. “It’s a fluid situation. If you’re the Fed, you want to be very flexible here,” Bank of America’s Harris said. “If you come into the meeting with the markets under pressure, there are good reasons not to walk. On the other hand, if things are calm and you feel good about containing the crisis, you are probably going to walk away. forward with the hike. The hike is a positive signal for the markets. It indicates the Fed is not panicking. An opportunity to reverse course, if necessary Harris said that if the Fed rises, there is precedent for the the central bank will temporarily reverse course if things go wrong.”Let’s just say that the regulatory measures and the targeted approach of supporting individual institutions doesn’t seem to be working,” he said. The Fed can cut rates to deal with financial problems.” For example, in 1987 the central bank cut rates immediately after the stock market crash and then started to rise again, Harris noted. In addition, the Fed cut rates rate in 1998 due to the d Long-term capital management disappeared, but then rose again. “It’s a good example where the Fed can juggle two issues at the same time,” he said. “You deal with the immediate crisis, and once things calm down and things are less fragile, you go back to your regular schedule.” Harris said the economy could have an impact. “I think it would be surprising if there were no negative impact on growth, even if the crisis resolves quickly,” he said. “It’s kind of another little warning sign for people that the economy is likely to be weak going forward.” If the economy is strong enough, the Fed could send the wrong message if it does not rise. “If they don’t go up when the economy is strong, they look like there’s a skeleton in the closet,” Harris said. He said that unlike the great financial crisis of 2008, the financial system does not appear vulnerable and consumers are in better shape. “In the current period, you don’t have a big industry like the housing market with a big meltdown in credit standards,” Harris said. “You test the economy and the markets when you raise rates…It’s like Warren Buffett’s phrase: you find out who’s swimming naked when the tide goes out.” Harris said it’s no surprise there’s been a fallout from the speed and scale of the Fed’s policy actions, which began a year ago when the central bank raised rates zero for the first time. The federal funds rate range is now between 4.50% and 4.75%. “The Fed has gone from remarkably dovish to extremely hawkish. Some institutions are going to be in trouble when there’s such a dramatic change in the interest rate environment,” he said.
