The Fed faces a blurrier outlook as it looks to weigh in on a rate hike
Analysts are expecting a 0.25% rise this time around, but the turmoil in the banking sector has made any expectations far less certain.
WASHINGTON — The Federal Reserve is grappling with a more murky economic picture, clouded by banking turmoil and still-high inflation, just as it is about to decide whether to keep raising interest rates or pause.
However, the Fed will not only have to decide whether to continue its year-long streak of rate hikes, despite the nervousness that has gripped the financial industry. Politicians will also try to look into the future and predict likely paths for growth, employment, inflation and their own interest rates.
Those forecasts will be released on Wednesday, when most economists expect the Fed to announce a relatively modest quarter-point hike in its base rate, the ninth hike since March last year.
Forecasts this time will be especially difficult. In their latest December forecasts, Fed officials suggested they would raise the short-term rate to around 5.1%, about half a point above the current level. Some Fed watchers expect policymakers to raise that forecast to 5.3% on Wednesday.
But the turmoil in the banking sector has made any expectations much less certain. The Fed meeting comes less than two weeks after the Silicon Valley bank collapsed in the second-biggest banking crash in American history. This shock was followed by the collapse of another major bank, Signature Bank. A third, First Republic Bank, was saved from collapse by a $30 billion cash injection.
Given the heightened uncertainty looming over the financial system, there is little chance that the Fed will may decide not to publish its usual quarterly forecasts. Three years ago, when the pandemic hit, the Fed moved its scheduled policy meeting to Sunday instead of Tuesday and Wednesday to urgently address the economic problems caused by new restrictions on the pandemic. After this meeting, the Fed did not publish quarterly forecasts.
At the time, Powell said that releasing economic and interest rate forecasts when the impact of the COVID-19 pandemic was so unclear “may have been more of a hindrance to clear communication than a help.” However, the unusual decision at the time was as much a reflection of the chaos of the early pandemic as it was of the uncertainty of the outlook.
If the Fed raises its key rate by a quarter point on Wednesday, it will reach about 4.9%, the highest rate in nearly 16 years. Earlier this month, Powell said in congressional testimony that a half-point rate hike is possible at this week’s meeting. The banking crisis suddenly turned this perspective upside down.
It will not be an easy task for the 11 Fed officials who will vote on the rate decision. With hiring still high, consumers still spending, and inflation still high, raising the rate would normally be an easy move.
Not this time. The Fed is expected to treat inflation and financial turmoil as two separate issues to be addressed simultaneously with separate instruments: higher rates to fight inflation and more Fed lending to banks to calm financial turmoil.
Complicating matters is the difficulty of determining the impact on the economy of the collapse of Silicon Valley and Signature. The Fed, the Federal Deposit Insurance Corporation and the Treasury Department have agreed to insure all deposits at these banks, including those that exceed the $250,000 limit. The Fed has also created a new lending program so banks can access cash to pay back savers if needed.
But economists warn that many medium and small banks are likely to become more cautious in their lending in order to preserve capital. Tighter bank credit can, in turn, reduce business spending on new software, hardware, and buildings. It can also make it harder for consumers to get auto or other loans.
Some economists fear that this credit slowdown could be enough to send the economy into recession. Wall Street traders are betting that a weaker economy will force the Fed to start cutting rates this summer. By the end of the year, futures markets were down three-quarters of a point.
The Fed would probably welcome slower growth, which would help bring inflation down. But few economists are sure what the consequences of the cut in bank lending will be.
The most recent data continues to point to a resilient economy and rampant hiring. Employers added 311,000 jobs in February, the government said earlier this month. And while the unemployment rate rose from 3.4% to a still low 3.6%, this mostly reflected an influx of new job seekers who were not immediately hired.
Consumer spending was strong in January, thanks in part to a large cost-of-living adjustment for the 70 million recipients of Social Security and other benefits. The Federal Reserve Bank of Atlanta predicts the economy will grow at a healthy 3.2% annual rate in the first three months of this year.
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