Markets

Fed preview: A quarter-point hike is expected but a pause is possible

Wed 22 Mar 23, 3:27pm (AEST)
US 12 Federal Reserve Fed
Source: iStock

Key Points

  • The Fed is expected to raise interest rates by 25 basis points on Thursday
  • However, there is a possibility of a pause in the hiking cycle due to stress in the banking system
  • Regardless of the decision, the market is expecting 100 bps worth of cuts by the September FOMC

Thursday morning will mark another high stakes Fed interest rate decision and potentially its first pause since the beginning of the hiking cycle last March.

The consensus view is still a 25 basis point hike to take the fed funds rate to 4.75% - 5.0%, the highest since 2007 on the eve of the global financial crisis. But the likelihood of a pause should not be underestimated.

In this piece, we’ll explore some of the commentary from Wall Street banks and what they’re expecting.

Current market expectations

The current market pricing for Thursday’s FOMC decision via CME’s Fedwatch tool is:

  • Cut 25 bps: 0%

  • Unchanged: 15.1%

  • Hike 25 bps: 84.9%

  • Hike 50 bps: 0%

The percentages are somewhat in-line with what Wall Street banks are expecting, including:

  • Team 25 bps: Bank of America, Barclays, Deutsche Bank, JPMorgan, Morgan Stanley

  • Team pause: Goldman Sachs, Wells Fargo

  • Team 25 bp cut: Nomura

Goldman sees a pause

“We expect the FOMC to pause at its March meeting this week because of stress in the banking system. 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 mid-size banks will prove sufficient,” Goldman Sachs said in a note on Tuesday.

Goldman believes that the stress in the banking system remains the “most immediate concern for now” and the battle to suppress inflation “looks less urgent” given the sharp decline in both near-term and long-term inflation expectations.

“In our central case, tighter lending standards resulting from the banking stress subtract 0.25% - 0.5% percentage points from GDP growth in 2023, equivalent to the impact of 25-50 bp of tightening in our financial conditions index or 25-50 bp of Fed rate hikes.”

“The FOMC can get back on track quickly, if appropriate, and the banking stress could have disinflationary effects,” the analysts added. 

Wells Fargo is in the same boat, suggesting that “the rapid tightening in financial conditions alongside the uncertainty of the situation makes us lean towards the FOMC taking a pause from its hiking campaign at its upcoming meeting.” 

Beyond March

Regardless of whether or not we see 25 bps or a pause tomorrow, the market seems certain that the hiking cycle is done and dusted. It’s currently pricing 100 bps of cuts by the September FOMC meeting.

Likewise, the US 2-year Treasury yield – which measures short-term interest rate expectations – is now trading at just under 4.0%. A week ago it was above 5.0%.

US02Y 2023-03-22 15-20-59
US 2-year Treasury yield

This slump reflects the largest 5-day decline in yields since the October 1987 crash. So, March hike or not – it’s expecting cuts thereafter.

Tech and bank stocks

The US Financials sector has lost more than US$450 billion of market cap while mega cap tech stocks have gained over US$500 billion of market cap. 

Does this trend reverse if the Fed and US government steps up efforts to support and end the banking crisis? Or does the easing of monetary conditions set the stage for a new bull run for tech?

S5INFT 2023-03-22 15-23-43
S&P 500 Tech (blue) vs. Financials (orange) performance over the last three months (Source: TradingView)

 

Written By

Kerry Sun

Content Strategist

Kerry holds a Bachelor of Commerce from Monash University. He is an avid swing trader, focused on technical set ups and breakouts. Outside of writing and trading, Kerry is a big UFC fan, loves poker and training Muay Thai. Connect via LinkedIn or email.

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