The Federal Open Market Committee (FOMC) will announce its interest rate decision later today. The federal funds futures market is discounting about an 80% chance for the Fed to raise its federal funds target range by +25 bp to 4.75-5.00% from the current 4.50-4.75%. Since the collapse of Silicon Valley Bank earlier this month and other signs of distress in the banking system, the Fed needs to walk a tightrope as it grapples with both high inflation and a crisis of confidence in the banking sector.
There are no easy options for the Federal Reserve. If the FOMC decides to pause and not raise interest rates, it could signal to the markets that the Fed is not confident in the banking system's resiliency. However, if the Fed raises interest rates, it risks adding to bank stress that could spook the markets. Post FOMC-meeting comments today from Fed Chair Powell are likely to indicate how concerned the Fed is about the banking system and the economy.
The FOMC is likely to raise the fed funds target range by 25 bp today because inflation is still too high, and Fed Chair Powell wants to signal to markets the separation between monetary policy and financial stability tools. Powell may say that interest rate policy is the primary tool for achieving the Fed’s dual mandate of price stability and full employment, and interest rates shouldn’t be used to address financial stability issues.
To address liquidity concerns, the Fed on March 12 announced a new "Bank Term Funding Program" that offers 1-year loans to banks up to $25 billion with easier terms than it typically provides. The Fed also relaxed terms for lending through its discount window, its main direct lending facility. The Fed also developed additional liquidity tools during the global financial crisis and the pandemic that could be used if the banking situation deteriorates.
The FOMC today will issue updated interest rate projections and offer guidance on whether they still expect any additional interest rate increases this year. In December, the FOMC expected a peak federal funds rate of 5.1% by later this year.
The FOMC today may also decide to slow or pause its quantitative tightening campaign to keep ample reserves in the financial system to address liquidity risks. The Fed is currently reducing its balance sheet as it lets $60 billion of Treasuries and $35 billion of mortgage-backed securities (MBS) runoff from its balance sheet monthly. With inflation still too high, there are no easy options for the Fed, so it may decide that raising rates by 25 bp outweighs the risk of not doing anything.
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On the date of publication, Rich Asplund did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
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