Fed expected to pause rate hikes until May after financial system stabilizes: Expert

ISTANBUL

The US Federal Reserve is expected to pause interest rate increases on Wednesday, but continue rate hikes at its next meeting after the US financial system and banking outlook are stabilized, according to an expert.

"I expect the Fed to pause their rate hikes this week, but to resume tightening at their May meeting after policymakers have stabilized the financial system," Mark Zandi, the chief economist at Moody's Analytics, told Anadolu via email.

The US central bank on Tuesday has kicked off its most critical two-day meeting of the year as the American banking system faces a crisis amid the demise of four banking institutions.

Within a matter of weeks in the US, Silvergate Bank, Silicon Valley Bank (SVB), Signature Bank, and First Republic Bank have gone under, causing panic among Wall Street and investors, but most especially depositors.

It is now a question whether the banks' failures would have a spillover effect on the rest of the US economy, and by and large the rest of the world, especially in the aftermath of the Swiss bank Credit Suisse's demise in Europe.

Zandi noted that the failures of SVB, Signature Bank, and Silvergate Bank, with assets collectively close to $325 billion, along with the "travails" of the large Swiss bank Credit Suisse, have "roiled" the global financial system.

He argued that the Fed will be under pressure this week to pause rate hikes, since financial stability has suddenly become its number-one priority, adding: "It would seem incongruent for the Fed to establish a credit facility to support liquidity in the banking system one week and raise interest rates the next."

The expert, however, noted that once the US financial system settles in the coming weeks, the Fed is expected to "pivot back" to addressing the high inflation and increase interest rates by 25 basis points each in its May and June meetings.

Before the latest US banking crisis, the probability of Fed making a rate hike of 50 basis points was above 50%, according to the FedWatch Tool provided by the US-based global markets company the Chicago Mercantile Exchange Group.

While that level fell to zero suddenly in the aftermath of the banking crisis, the probability of a 25 basis-point rate hike stood at 86% as of Tuesday, while there is a 14% probability of keeping the interest rate steady.

The Fed made a total of 425-point interest rate increases on seven occasions last year, which included four massive rate hikes of 75 basis points. Those were followed by a smaller rate hike of 25 basis points on Feb. 1.

"Inflation is too high. But, pausing rate hikes to ensure the banking system is on firm financial ground won’t jeopardize the goal of getting inflation down in a timely way," Zandi said.

"Besides, the economic fallout from the banking crisis will slow growth and be disinflationary," he added.