The European Central Bank raised its benchmark interest rate by 50 basis points on Thursday. Will the U.S. Federal Reserve follow suit?
The answer is yes, albeit a smaller-sized move, economists said Thursday.
The ECB rate hike is a “model” that the Fed can use, said Vincent Reinhart, chief economist at Dreyfus and Mellon.
“The ECB move was an action driven by their macroeconomic responsibility. And it was couched in concern for how things might unfold, they said ‘carefully monitoring’ a lot. I think that’s what the Fed will do,” Reinhart added.
The Fed meeting will start later Tuesday and will release its decision at 2 p.m. Eastern Wednesday. Fed Chair Jerome Powell will follow with a press conference a half hour later.
Fears of financial-sector contagion from the collapse of Silicon Valley Bank have eased in the past 24 hours.
Late Thursday, a group of leading banks agreed to deposit $ 30 billion in First Republic, the San Francisco-based regional bank that has been under the microscope since last week’s collapse of Silicon Valley Bank.
Treasury Secretary Janet Yellen and Powell welcomed the move, with Yellen stressing the U.S. banking system was sound.
Earlier, embattled Swiss banking giant Credit Suisse said it would get financial help from the Swiss central bank.
Powell and his colleagues only need to raise rates by a quarter percentage point because they started ahead of their ECB colleagues in Frankfurt, economists explained Thursday. A larger, half-percentage move was seen as too large given the uncertain environment.
Pausing would send a negative signal that the Fed was worried about the financial sector, Reinhart said.
Neil Dutta, head of macroeconomic research at Renaissance Macro Research, agreed that the ECB showed the Fed that the coast was clear for continued hikes.
“If the ECB can get away with 50, I think the Fed can go 25,” Dutta said.
Before the collapse of Silicon Valley Bank, the Fed was said to be leaning toward a 50-basis-point move. Powell had left the door wide open for a larger move after two days of testimony to Congress earlier this month.
The most recent economic data would justify that larger move, Dutta said.
“Upwardly revised GDP, core retail sales, jobless claims and housing are all pretty strong. We went into this shock pretty strong,” Dutta said.
Instead of signaling that “ongoing rate hikes” would occur, Reinhart said the Fed would signal that further rate hikes would likely be appropriate, but that the central bank was monitoring financial conditions closely.
“Gradualism works. They can say they are doing more 25s, but no one will believe Powell,” Reinhart said.
Powell won’t feel the need to convince markets about more hikes, because if markets snapped back to where the Fed is, that would be a significant tightening, he said.
Not everyone agrees that a hike next week is in the offing.
Robert Brusca, president of FAO Economics, said that the Fed should stop the tightening process, at least for now.
Financial contagion, like the smell of perfume, has a tendency to linger, he said — and reappear suddenly.
Former Fed Gov. Daniel Tarullo said the shock to the banking system this week will already produce a significant tightening of financial conditions.
“In some sense what has happened is the equivalent of a federal funds increase,” Tarullo said, in an interview on CNBC.
That could be used to justify a pause at the March meeting, he said.
Trading has been volatile all week but, at the moment, traders in the fed funds futures market see more than an 80% chance the Fed will raise its benchmark rate by a quarter of a percentage point, to a range of 4.75%-5%, next week.
Traders see only one more quarter-point hike after that, which would put the Fed’s endpoint in a range of 5%-5.25%.
Rate cuts will follow swiftly, according to traders. But they now expect fewer cuts by year’s end than they did earlier this week.
The Fed will release its estimate of path of interest rates next week. It is likely to be more hawkish than what the market now expects, Reinhart of Dreyfus and Mellon said, but Powell may be able to distance himself from this view.
Stocks DJIA, +1.20% SPX, +0.89% were set to open higher on Tuesday, and the yield on the 10-year Treasury note TMUBMUSD10Y, 3.585% rose to 3.57%.