U.S. Federal Reserve Chairman Jerome Powell speaks to reporters after the Fed raised its target interest rate by a quarter of a percentage point, during a news conference at the Federal Reserve Building in Washington on February 1, 2023.

Jonathan Ernst | Reuters

Even with the turmoil in the banking sector and uncertainty ahead, the Federal Reserve is likely to approve a quarter-percentage-point rate hike next week, according to market pricing and many Wall Street experts.

Interest rate expectations have fluctuated rapidly over the past two weeks, ranging from a halfway point hike to hold the line and even at one point there was talk that the Fed might cut interest rates.

However, there has been consensus that the Fed chairman Jerome Powell and his fellow central bankers will want to signal that while they are attuned to the upheaval in the financial sector, it is important to continue the fight to bring down inflation.

That is likely to take the form of an increase of 0.25 percentage points, or 25 basis points, accompanied by assurances that there is no pre-set path forward. The outlook may change depending on market behavior in the coming days, but the indication is that the Fed will hike.

“They have to do something or they lose credibility,” said Doug Roberts, founder and chief investment strategist at Channel Capital Research. “They want to do 25, and the 25 sends a message. But it’s really going to depend on the comments afterward, what Powell says publicly. … I don’t think he’s going to make the 180-degree shift that everybody’s talking about.”

Markets largely agree that the Fed will raise.

As of Friday afternoon, there was about a 75% chance of a quarter-point rally, according to CME Group data use the fed funds futures contract as a guide. The other 25% were in the no-hike camp, predicting that policymakers could step back from the aggressive austerity campaign that began just over a year ago.

Goldman Sachs is one of the most widely watched forecasters to see no change in interest rates, as it expects central banks to generally “adopt a more cautious short-term stance to avoid worsening market fears of further bank stress.”

A matter of stability

Whichever way the Fed goes, it is likely to face criticism.

“This might be one of those times where there’s a gap between what they should do and what I think they will do. They definitely shouldn’t be tightening policy,” said Mark Zandi, chief economist at Moody’s Analytics. “People are really on edge, and any little thing can push them over the edge, so I just don’t get it. Why can’t you just pivot a little bit here and focus on financial stability?”

A rate hike would come just over a week after other regulators rolled out an emergency loan facility to stop a crisis of confidence in the banking industry.

The closure of Silicon Valley Bank and Signature Bank, along with news about, among other things,nstability elsewhererocked financial markets and set off fears of more to come.

Zandi, who has predicted no rate hike, said it is very unusual and dangerous to see monetary policy tightening under these conditions.

“You won’t lose your fight against inflation with a break here. But you could lose the financial system,” he said. “So I just don’t understand the rationale for tightening policy in the current environment.”

Still, most on Wall Street believe the Fed will continue with its policy stance.

Cuts are still expected at the end of the year

In fact, Bank of America said political moves from last Sunday backing depositors’ cash and supporting liquidity-strapped banks gives the Fed the flexibility to raise.

“The recent market turmoil stemming from distress at several regional banks certainly calls for more caution, but the robust actions by policymakers to trigger systemic risk exemptions … will likely limit the fallout,” Bank of America economist Michael Gapen said in a client note. “That said, events remain fluid and other stress events could materialize between now and next Wednesday, prompting the Fed to pause its rate hike cycle.”

In fact, more bank failures over the weekend could once again send politics into a tailspin.

An important caveat to market expectations is that traders do not believe any further rate hikes will last. Current pricing indicates interest rate cuts ahead, placing the Fed’s benchmark rate in a target range of around 4% by year-end. A rise on Wednesday would put the range between 4.75%-5%.

Citigroup also expects a quarter-point hike, reasoning that central banks “will turn their attention back to the inflation battle that is likely to require further increases in key interest rates,” the firm said in a note.

However, the market hasn’t had the benefit of hearing from Fed speakers since the financial turmoil began, so it will be harder to gauge how officials feel about the latest events and how they fit into the policy framework.

The biggest concern is that the Fed’s actions to stop inflation will eventually take the economy into at least a shallow recession. Zandi said a hike next week would raise those odds.

“I think more rational managers will prevail, but it is possible that they are so focused on inflation that they are willing to take their chances with the financial system,” he said. “I thought we could get through this period without a recession, but it required some pretty good policy from the Fed.

“If they raise interest rates, that qualifies as a mistake, and I would call it a serious mistake,” Zandi added. “Recession risks will go significantly higher at that point.”