Investors expect Fed to go through with rate hike despite banking turmoil

Investors expect the Federal Reserve will raise interest rates this week despite the fallout from Silicon Valley Bank’s collapse.

There is now a 69% chance that the Fed will hike rates at its meeting this week by 0.25 of a percentage point, according to CME Group’s FedWatch tool, which calculates the probability using futures contract prices for rates in the short-term market targeted by the Fed.

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Investors are assigning 31% odds that the central bank’s key overnight rate, which is now 4.50% to 4.75%, will remain where it is as the Fed walks the tightrope of lowering inflation without triggering a financial meltdown, given the uncertainty in the banking sector.

A rate hike would send a sign that the Fed continues to see inflation as a bigger threat than the economic repercussions of the uncertainty about the banking system.

Some prominent bankers had called for the Fed to back away from rate hikes altogether in light of the fears about banks.

“While policymakers have responded aggressively to shore up the financial system, markets appear to be less than fully convinced that efforts to support small and midsize banks will prove sufficient. We think Fed officials will therefore share our view that stress in the banking system remains the most immediate concern for now,” Goldman Sachs said in a report Monday.

Meanwhile, Nomura, a major Japanese financial holding company, actually expects the Fed to slash rates by 0.25 of a point on Wednesday despite the Fed’s and regulators’ recent moves to shore up confidence in the banking system. “However, judging by the market’s reaction, financial markets seem to view these policy actions as insufficient, as stock prices for the US financial sector continue to decline as of this writing,” Nomura economists Aichi Amemiya and Jacob Meyer said on Monday.

Nevertheless, investors are betting the Fed will raise its target this week. But expectations for interest rate changes for the rest of the year are uncertain.

A month ago, the consensus was that rates would go higher this year as the central bank tries to contain inflation, but markets now only imply a 4.7% chance that the Fed’s target rate will be at its current level or higher following the central bank’s December meeting. There is also an 18.4% chance that rates will be slashed by a whole percentage point or more from now until the end of the year.

Labor market statistics provide reassurance about the strength of the economy. Employers added 311,000 jobs in February, which is more than expected. The unemployment rate slightly increased to 3.6%, which continues to be a low figure by historical standards.

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But as interest rates remain high (and perhaps go even higher), concerns about a recession, particularly given the backdrop of the banking crisis, have increased.

Last week, Goldman Sachs raised the chances of a recession in the United States to 35%, up 10 points from its previous prediction. The firm said the forecast mirrors “increased near-term uncertainty around the economic effects of small bank stress.”