Federal Reserve hiking by 50bp next Wednesday would signal it was wrong

Federal Reserve hiked the rate by 25bp. Crude oil prices may be stabilizing

Federal Reserve rate decision – 22/03 – before the recent events around the collapse of Silicon Valley Bank, and the subsequent rescue package that followed, the calculus around this week's Federal Reserve rate decision had been a relatively simple one. Whether to raise rates by 25bps or 50bps. The sharp selloff in US banks and the ensuing volatility in the last few days appears to have trumped concerns about inflation, even with the recent payrolls report, which was another solid number.

These concerns about the effects of rising rates on the banking sector and wider economy have even seen some suggest we might see a pause or even a rate cut this week. This seems somewhat of an overreaction, even with the recent volatility and could prompt the opposite effect by spooking markets further. By cutting rates the Fed would in effect be signalling there is a wider problem, prompting the very reaction they want to avoid. Powell's recent comments to US lawmakers have shown the Fed is becoming increasingly concerned about rising prices, and despite recent events this is unlikely to have changed.

The wider question will be how much the FOMC sees fit to raise its dot plot guidance when it comes to the number of rate hikes to expect over the rest of this year in light of recent economic data. There had been some argument, prior to SVB that the Fed should upshift to a 50bps rate hike, however, that would be compounding one mistake with another. Given the strength of recent economic data, it would have been wiser for the Fed to have done 50bps in February and not downshifted to 25bps, however, that's ancient history now.

A move back to 50bps would signal the Fed made a mistake and is being reactive. Much better now to hike by 25bps this week and guide to further rate hikes of 25bps in the coming months, while changing their forecasts for GDP and inflation. Bond markets had appeared to have adjusted to the new dynamic of higher rates for longer, and in spite of the recent volatility financial conditions are now tighter than they were at the start of February. How Powell manages market expectations this week, especially with respect to how recent events have affected this week's decision will be as equally important as the decision itself. A rate hike of 25bps still seems the most probable outcome, with the bigger risk being that he overcompensates after the market's buoyant reaction to his February press conference, and negative reaction to his testimony to US lawmakers. He needs to steer a middle ground.

Minneapolis Fed President Neel Kashkari has always maintained a terminal rate of 5.4% is his base case and market estimates did briefly move up to those levels earlier this month, although we have since fallen from those peaks. Inflation is now starting to fall back, even as core prices remain sticky. The recent volatility has seen markets start to price in rate cuts later this year, although this could change if things start to calm down. If inflation remains sticky, rate cuts seem highly unlikely anytime soon if the Fed is to get back to its 2% target, and that's something the markets haven't yet come to terms with.

Federal Reserve hiked the rate by 25bp. Crude oil prices may be stabilizing

Michael Hewson

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