Federal Reserve expected to raise interest rates amidst banking crisis concerns

The Federal Reserve is expected to increase its fed funds target rate range by a quarter point to 4.75% to 5% on Wednesday afternoon. However, it also faces the tough task of reassuring the markets that it can stem a worse banking crisis. The Fed is considering using its interest rate tools at the same time as it is trying to soothe markets and stop further bank runs. The fear is that rising rates could put further pressure on banking institutions and crimp lending further, which could hurt small businesses and other borrowers. Federal regulators have stepped in to guarantee deposits at failed Silicon Valley Bank and Signature Bank, and they provided more favorable loans to banks for a period of up to one year. Investors will be looking for assurances from Fed Chairman Jerome Powell that the central bank can contain the banking problems.

The markets have been whipsawed in the last month, first by a hawkish-sounding Fed and then by fears of contagion in the banking system. Fed officials begin their two-day meeting on Tuesday. This event kicks off just two weeks after Powell warned a congressional committee that the Fed may have to hike rates even more than expected because of its battle with inflation. Those comments sent interest rates soaring. A few days later, the sudden collapse of Silicon Valley Bank stunned markets, sending bond yields dramatically lower. Expectations for Fed rate hikes also moved dramatically.

The central bank will have to explain its double-barreled policy. “You have to show you can walk and chew gum at the same time, using your lender-of-last-resort powers to quell any fears about deposit flights at medium-sized banks,” says Michael Gapen, Chief U.S. Economist at Bank of America. Gapen expects Powell to explain that the Fed is fighting inflation through its rate hikes but then also assure markets that the central bank can use other tools to preserve financial stability.

Gapen expects the Fed’s forecasts could show it expects a higher terminal rate or end point for rate hikes than it did in December. He said it could rise to about a level of 5.4% for 2023, from an earlier projection of 5.1%. Jimmy Chang, Chief Investment Officer at Rockefeller Global Family Office, said he expects the Fed to raise interest rates by a quarter point to instill confidence but then signal it is finished with rate hikes.

Diane Swonk, Chief Economist at KPMG, said she expects the Fed is likely to pause its rate hiking because of economic uncertainty and the fact that the contraction in bank lending will be equivalent to a tightening of Fed policy. She also does not expect any guidance on future hikes for now, and Powell could stress the Fed’s data dependence.

The Fed is scheduled to release its rate decision along with its new economic projections at 2 p.m. ET Wednesday, with Powell speaking at 2:30 p.m. ET. Investors are looking to the Fed to provide a clear message on how it plans to balance its inflation-fighting mandate while also ensuring financial stability.