Fed is set to approve a quarter-point rate increase next week, in spite of market uncertainty

Despite the instability in the banking sector and the upcoming uncertainty, several Wall Street analysts believe that the Federal Reserve will approve a hike in interest rates of one-quarter of a percentage point next week.

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During the past two weeks, rate expectations have been on a pendulum swing, shifting from a half-point boost to maintaining the line and even at one time, even chatter that the Fed may lower rates.

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Yet, it has become clear that Fed Chairman Jerome Powell and his fellow central bankers will want to convey that, despite being aware of the turmoil in the financial industry, it is crucial to keep up the fight to reduce inflation.

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This will most likely come in the form of a 0.25 percentage point, or 25 basis point, hike and reassurance that there is no predetermined course for the future. The prediction may alter depending on how the markets perform in the upcoming days, but it now favors a Fed rate hike.

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Doug Roberts, the company's founder and chief investment strategist, stated that "if they don't act, they risk losing credibility. The 25 sends a message, and they want to do 25. Yet, it will mostly depend on the remarks that follow and what Powell publicly says. I don't believe he will make the 180-degree turn everyone is predicting."

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Markets generally concur that the Fed will raise interest rates.

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According to CME Group data using fed funds futures contracts as a benchmark, there was approximately a 75% possibility of a quarter-point rise as of Friday afternoon. The remaining 25% were in favor of continuing as is, hoping that officials will back off from their dramatic tightening drive that started less than a year ago.

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One of the most well-known forecasters, Goldman Sachs, predicts that rates will remain unchanged because it expects central bankers "to adopt a more cautious short-term attitude in order to prevent aggravating market fears of future banking stress."

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A question of stability

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Any decision the Fed makes will probably draw criticism.

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"This may be one of those instances where what they ought to do and what I anticipate they will do are at odds with one another. Definitely do not tighten policy, according to Moody's Analytics Chief Economist Mark Zandi. "I just don't get it. People are very on edge, and any little thing may throw them over the brink. Why not just make a slight change of direction and concentrate on financial security? ”

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After other regulators launched an emergency lending facility to stop a crisis of confidence in the banking sector, a rate increase would occur just over a week later.

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Financial markets were shaken by the closure of Silicon Valley Bank and Signature Bank as well as reports of instability abroad, which stoked concerns about further volatility.

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Zandi, who has predicted no rate hike, stated that it is extremely rare and risky to see monetary policy tightening in these circumstances.

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"With this respite, you won't lose the fight against inflation. Yet, he warned, "you might lose the financial system. I simply don't understand the justification for tightening the policy in the current situation.

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Yet, the majority of Wall Street believes the Fed will continue in its current policy direction.

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Cuts still expected by year’s end

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In contrast, Bank of America claimed that the policy changes made last Sunday to protect depositor funds and support banks with limited liquidity gave the Fed the freedom to raise interest rates.

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"The current market turmoil arising from trouble in multiple regional banks undoubtedly calls for additional prudence, but the robust response by regulators to trigger systemic risk exclusions... is likely to limit impact," wrote Bank of America economist Michael Gapen in a client note. That being said, things are still in a fluid state and additional stressful situations could arise between now and next Wednesday, forcing the Fed to halt its rate-hike cycle.

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Moreover, additional bank failures over the weekend might cause the policy to become confused once more.

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The fact that traders don't believe any additional rate hikes will hold is a significant qualification to market expectations. The Fed's benchmark funds rate is expected to decrease in the near future, reaching its target range of 4% by year's end, according to the current pricing. If there was a hike on Wednesday, the range would be 4.75 to 5%.

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Citing the fact that central banks "will devote emphasis back to the inflation fight which is expected to necessitate further hikes in policy rates," Citigroup predicted a quarter-point increase as well.

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It will be more challenging to determine how Fed officials feel about the most recent events and how they fit into the policy framework because the market has not had the benefit of hearing from Fed speakers since the financial turbulence started.

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The largest concern is that the Fed's actions to stop inflation would eventually push the economy into a recession, if not a deep one. A hike next week, according to Zandi, would increase those chances.

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It's possible that they are so fixated on inflation that they are willing to take a gamble with the financial system, he said, adding that he believes more sane minds will triumph. "I had hoped we might get through this era without a recession, but the Fed would need to make some relatively sound policy decisions.

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"If they raise rates, that qualifies as an error, and I would call it an egregious error," Zandi continued. "At that moment, the risks of a recession will materially increase."