Expectations are high that the Federal Reserve will hike 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 wild ride, Thursday’s fed funds futures reflected a more than 80% chance the central bank would hike rates by 25 basis points next Wednesday. One basis point corresponds to 0.01 percentage points. Ethan Harris, head of global economic research at Bank of America, said the company expects the Fed to hike rates by a quarter point, but the central bank could change course if necessary. “We’ve got the Fed doing three 25 basis point hikes, including next week,” he said. “This is assuming that regulatory efforts to support the banking system are effective and that further negative news flow is limited, allowing the Fed to shift its focus back to inflation. It’s tight for next week as it really depends on what the markets do when the Fed meets.” Stocks closed higher on Thursday, with regional bank shares rising. Treasury yields also rose as investors learned That 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 led the way with a half-point rate hike, concerns There were also reassurances on the health of Credit Suisse after the Swiss National Bank said on Wednesday the bank was well capitalized and would provide liquidity if needed.A choppy situation Worries about bank contagion following the collapse of the Silicon Valley bank drove buyers into Treasuries and boosted risky assets like stocks and oil de traded with large fluctuations since then. The yield, which most closely reflects Fed policy, rose to 4.17% in late trade Thursday, from a low below 3.9% in morning trade. Yields move inversely to price. The market chances of a US Federal Reserve rate hike rose sharply on Thursday from 50% on Wednesday. Those expectations have been swinging wildly. They were up 50% Wednesday after wide swings, but there were also traders who had expected a half-percentage-point hike before the Silicon Valley bank collapse. As news broke about First Republic, the ratings topped 85% at one point Thursday afternoon before falling back to closer to 80%. Economists have differing views on how the central bank will respond to recent US bank collapses and concerns over Credit Suisse. JPMorgan economists expect the Fed to hike rates next week and again in May. However, economists at Goldman Sachs said they believe policymakers will hold off on a hike. Moody’s Analytics does not expect a rate hike and believes the Fed could signal that it is done raising rates. “This is a fluid situation. If you’re the Fed, you want to be very flexible here,” said Bank of America’s Harris. “If you’re going into the markets meeting under stress, there are pretty good reasons not to hike. On the other hand, if things are calm and you feel good about containing the crisis, you’re likely to continue with the hike. The hike is a positive signal to the markets. It says the Fed isn’t panicking.” An opportunity to reverse course if necessary Harris said when the Fed hikes, there is precedent for the central bank to temporarily reverse course when things are going badly. “Let’s guess On the other hand, regulatory action and the targeted approach of supporting individual institutions don’t seem to be working,” he said. “Eventually, the Fed may cut rates to deal with the financial woes.” For example, in 1987, the central bank cut rates immediately after after the stock market crash and then resumed raising rates, Harris noted. Also, the Fed cut rates in 1998 because of the decline in long-term capital management, but then went back to raising rates.”It’s a good example of the Fed solving two problems at the same time can juggle,” he said. “They deal with the immediate crisis and once things have settled down and things are less fragile If you are, return to your regular schedule.” Harris said the economy may see some impact. “I think it would be surprising if there was no negative impact on the growth picture even if the crisis is resolved 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 be sending the wrong message if it doesn’t hike. “If they don’t hike when the economy is strong, they make it look like there’s a skeleton in the closet,” Harris said. He said that unlike during the great financial crisis of 2008, the financial system is not vulnerable and consumers are in better shape. “In the current period, you don’t have a big sector like housing with a big collapse in credit standards,” Harris said. “You’re stressing the economy and the markets when you raise interest rates … It’s like Warren Buffett’s phrase: You find out who’s swimming naked when the tide recedes.” Harris said it wasn’t surprising that the speed and the magnitude of the Fed’s monetary policy moves, which began a year ago when the central bank raised rates from zero for the first time, had some impact. The policy rate range is now 4.50% to 4.75%. “The Fed has gone from remarkably dovish to extremely hawkish. Some institutions will run into trouble if the interest rate environment changes so dramatically,” he said.
Source : www.cnbc.com