MNI FED WATCH: 25BP Hike Likely Unless Banking Crisis Worsens

The Federal Reserve decides Wednesday whether to press ahead with a ninth straight interest-rate increase to fight inflation or keep rates steady amid an unfolding global financial crisis.

Former policymakers told MNI a quarter-point hike taking the fed funds rate target to 4.75% to 5.0% is a likely outcome as the U.S. central bank signals it has other tools to shore up financial stability. Investors are pricing in a 75% chance of a 25 bp move, followed by several rate cuts starting in June.

Pausing rate hikes with CPI at 6% would risk the Fed's inflation-fighting credibility and raise doubts about the effectiveness of its latest interventions, former Philadelphia Fed President Charles Plosser says. (See: MNI INTERVIEW: Fed Pause Would Undermine Credibility - Plosser)

But former Boston Fed chief Eric Rosengren and others urge the Fed to take a wait-and-see stance to see how the crisis is hitting the real economy.

RECALIBRATING

Until it's clear how much demand destruction will result from the collapse of Silicon Valley Bank and Signature Bank, and whether the banking industry reckoning leads to a credit crunch, "it doesn't make sense to be considering raising rates," Rosengren said in an interview.

Fed rate hike expectations have swung wildly in the lead-up to this week's meeting. Markets just two weeks ago had priced in a larger 50 bp March hike after Fed Chair Jerome Powell suggested rates may need to rise faster after labor market and inflation data came in stronger than expected.

Regardless of policy action this week the Fed can say it's recalibrating in light of a potentially large bank credit tightening without sacrificing the dual mandate objectives, former Fed governor Jeremy Stein told MNI.

The FOMC's March summary of economic projections are likely to "reflect an assumption that stability is restored," leaving the Fed to deal with more persistent inflation, former Atlanta Fed President Dennis Lockhart told MNI. The overall policy path isn't likely to show cuts this year even if individual dots are now more dispersed, he added.

FLUID SITUATION

Some tightening of credit as a result of bank failures could aid the Fed's inflation fight, so long as the pullback isn't too abrupt or severe, Lockhart said.

Analysts estimate the tightening of financial conditions in the past 10 days is equivalent to at least 25 bps of tightening, and the situation could become more volatile ahead of Wednesday's meeting.

A coordinated show of confidence in First Republic Bank, another midsize bank that experienced massive withdraws this month, hasn't prevented its shares from diving further Monday. That was after the Fed and other major central banks announced coordinated action to boost dollar liquidity as Swiss authorities brokered a deal for UBS to buy troubled rival Credit Suisse.