Will the Banking Crisis Force Fed to Pause Interest Rate Hikes?

The Fed’s next move is, unusually, up in the air

Federal Reserve Chair Jerome Powell testifies before the Senate Banking Committee March 7, 2023 in Washington, DC. Powell spoke on the state of the U.S. economy and suggested that interest rates will need to stay higher for longer than expected in order to curb inflation.

Win McNamee  / Getty Images

Policymakers at the Federal Reserve face a tough decision at their meeting this week: ratchet up its benchmark interest rate again to quell inflation, or hold steady to avoid stressing the financial system.

Key Takeaways

  • There's a 25% chance the Federal Reserve will keep its interest rate flat, and a 75% the Fed will hike it 25 basis points when it meets Wednesday, according to trading data.
  • The Fed might back off of its year-long campaign of raising rates to fight inflation for fear of destabilizing the financial system, which has been rocked by the failures of Silicon Valley and Signature banks. 
  • On the other hand, the Fed could stay focused on taming inflation and raise rates despite the risk of putting banks under more stress. 

The recent turmoil in the banking system set off by the collapse of Silicon Valley Bank forces the Fed to choose between its goals of fighting inflation and preventing more bank failures, experts said. 

“Inflation data say keep hiking. Financial market distress says stop,” economist Robert Fry said in a commentary.

Traders widely expect the Fed to stay focused on inflation and announce a 25 basis-point rate hike to its benchmark fed funds rate this Wednesday—the eighth rate hike in as many meetings. There’s about a 25% chance that Fed officials won’t raise the rate at all, according to CME’s FedWatch tool, which forecasts Fed rate hikes based on bond trading activity.

The uncertainty this close to a meeting is unusual since policymakers typically telegraph their intentions well in advance. The week before the Silicon Valley Bank collapse, Fed Chair Jerome Powell had told lawmakers to expect rate hikes to come fast and furious, because of hotter-than-expected inflation and economic data.

At the time, the comments cemented traders’ expectations that a 50-basis point hike was inevitable at the March 22 meeting. The failure of Silicon Valley Bank—which came about at least partly because of the Fed’s interest rate hikes—shifted expectations. 

The Fed could decide to pause its rate hikes in the name of avoiding more stress on the banking system. In the immediate aftermath of Silicon Valley Bank’s implosion, the government moved quickly to bail out the bank’s depositors and reassure the public that their money was safe in the nation’s banks.

Further bank runs and failures have yet to materialize. However, some economists point to ongoing fallout—such as Credit Suisse’s distressed sale to UBS—as a signal of how much stress the Fed’s rate hikes have already caused the financial system. 

Economists at Goldman Sachs forecast the Fed’s policy-setting body will err on the side of caution: 

“We expect the FOMC to pause at its March meeting this week because of stress in the banking system,” Goldman economist David Mericle wrote in a research note Monday. 

Article Sources
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  1. Federal Reserve. "Open Market Operations."

  2. CME Group. "FedWatch Tool."

  3. Treasury Department. "Joint Statement by the Department of the Treasury, Federal Reserve, and FDIC."

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