Expectations are high that the Federal Reserve will raise interest rates by a quarter point next week, but the central bank can still quickly change policy if the financial system becomes strained. After a wild ride, Thursday’s fed funds futures reflect more than 80% odds that the central bank will raise rates by 25 basis points next Wednesday. One basis point is equal to 0.01 of a percentage point. Ethan Harris, head of global economic research at Bank of America, said the company expected the Fed to raise rates by a quarter point, but the central bank could change course if needed. set. “We have the Fed triple hikes by 25 basis points, including next week,” he said. “That’s based on the assumption that regulatory efforts to support the banking system are effective and further negative news is limited, so the Fed could shift focus back to inflation. That’s a close call for next week because it really depends on what the market is doing when the Fed meets.” On Thursday, shares closed higher, with shares of regional banks climbing. Treasury yields also rose as investors learned that a consortium of 11 banks had agreed to deposit $30 billion in the First Bank of the Republic. Participating institutions include JPMorgan, Citigroup, PNC and Truist. Earlier, the European Central Bank went ahead with a half-point interest rate hike. Credit Suisse’s health concerns have also eased after the Swiss National Bank on Wednesday said it was well-capitalized and would provide liquidity if needed. A flexible situation Worries about bank contagion following the failure of the Silicon Valley Bank prompted buyers to look to Treasuries and buy into riskier assets, such as stocks and oil. mine. Since then, the yield on the 2-year Treasury note has traded with great volatility. Yields, which reflect Fed policy the most, rose to 4.17% late Thursday, from a low of just under 3.9% in morning trade. Yields move inversely with price. Market odds for a Federal Reserve rate hike rose sharply on Thursday, up from 50% on Wednesday. Expectations were frenzied. They were at 50% after Wednesday’s big swings, but there were also traders expecting half a percentage point gain ahead of the Silicon Valley Bank debacle. When news of the First Republic broke, the odds were at one point above 85% on Thursday afternoon before dropping to nearly 80%. Economists have different views on how the central bank will respond to recent US bank failures and worries about Credit Suisse. JPMorgan economists expect the Fed to raise rates next week and again in May. But Goldman Sachs economists said they don’t think policymakers will raise rates. Moody’s Analytics thinks interest rates won’t rise and the Fed could signal that it’s finished raising rates. “This is a fickle situation,” said Harris of Bank of America. If you’re the Fed, you want a lot of flexibility here. “If you go into the meeting with the market situation tense, there’s a pretty good case for not going up. On the other hand, if things are calm and you feel satisfied about having the crisis under control, you could continue to rise. The price increase is a positive signal for the market. It shows that the Fed is not panicking.” Harris said if the Fed raises rates, there is precedent for the central bank to temporarily reverse course if things go awry. “Assuming targeted management measures and approaches that support individual organizations are unlikely to work,” he said. “At some point, the Fed may cut rates to address financial problems.” For example, in 1987, the central bank cut interest rates shortly after the stock market crash and then went on to raise rates again, Harris notes. Also, the Fed cut rates in 1998 due to the collapse of Long Term Capital Management, but then it spiked again. “It’s a prime example of how the Fed can solve two problems at once,” he said. “You deal with the immediate crisis, and once things calm down and things are less fragile, you go back to your regularly scheduled program.” Harris said the economy could see some impact. “I think it would be surprising not to have some negative impact on the growth picture, even if the crisis is resolved quickly,” he said. “It’s another small warning sign for everyone that the economy is likely to weaken in the future.” If the economy is strong enough, the Fed could send the wrong message if it doesn’t raise rates. “If they don’t raise prices when the economy is strong, they’ll 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 does not appear to be vulnerable and consumers are in better shape. “In the current period, you don’t have a sector as big as the housing market with a major collapse in credit standards,” Harris said. “You’re testing the economy and the market when you raise interest rates… It’s like Warren Buffett said: You find out who’s naked when the tide goes out.” Harris said it’s not surprising that there’s been some negative impact from the speed and extent of the Fed’s policy moves, which began a year ago when the central bank first raised interest rates from… 0%. The federal funds rate range is currently at 4.50% to 4.75%. “The Fed has gone from being very dovish to being extremely hawkish,” he said. “Some institutions will be in trouble when there is a significant change in the interest rate environment.”
