U.S. Federal Reserve may keep rates unchanged next week, traders bet, with cuts to follow

Federal Reserve policy-makers are seen possibly putting their fight against inflation on pause next week, as turbulence at Credit Suisse renewed fears of a banking crisis and a government report showed U.S. retail prices fell in February.

Traders of futures tied to the Fed’s policy rate on Wednesday were pricing a slightly better than even chance that policy-makers will leave their benchmark lending rate in its current 4.5 per cent-4.75 per cent range at their upcoming meeting on March 21-22.

Traders also erased previous bets on the Fed raising rates any higher than the 4.75 per cent-5 per cent range, and are now pricing in rate cuts as soon as May or June, with the Fed policy rate seen ending the year a full percentage point lower than it is now.

Expectations for the U.S. central bank’s next move have swung wildly in recent days, after the sudden failure of two regional banks late last week triggered alarm about the health of the banking system and raised doubts about how much further the Fed may take what has been an aggressive fight against stubbornly high inflation.

Just a week ago Fed Chair Jerome Powell stoked expectations for a half-of-a-percentage point move at the upcoming meeting, with the Fed policy rate seen rising to a 5.5 per cent-5.75 per cent range in coming months.

After the failure on Friday of Silicon Valley Bank and on Saturday of Signature Bank, the Fed created an emergency program to guarantee deposits and try to stem further financial contagion.

That prompted futures traders to slash their rate-hike expectations, only to partially reverse those bets on Tuesday after a report showing inflation is cooling far too slowly for comfort.

By the end of Tuesday traders had priced about a 70 per cent probability of a quarter-percentage point rate in March, with likely one more increase of the same size in May.

Now, with the banking crisis seemingly rekindled and banking stocks again under pressure, traders are looking for one more Fed rate hike if that, and then a string of interest-rate reductions, with the rate ending this year in a 3.5 per cent-3.75 per cent range.

“It’s conceivable that we’ve seen the peak in market interest rates this cycle,” said John Lynch, Chief Investment Officer for Comerica Wealth Management.

Retail sales fell in February, but consumer spending continued to show underlying strength and U.S. producer prices unexpectedly fell last month with the rise in prices in January not as large as initially thought, offering some hopeful signs in the fight against inflation, separate U.S. government reports showed on Wednesday.

A key inflation report earlier this week though showed a 6 per cent rise in the consumer price index last month from a year earlier. It was the smallest gain in a year and a half, but still far too high for the central bank to declare its work is done. The Fed’s inflation target is 2 per cent.

“The Fed has a very difficult policy decision to make at next week’s meeting – should it hold interest rates unchanged in the wake of the SVB collapse to shore up market confidence or, with core inflation proving sticky, should it keep on hiking interest rates?” said Paul Ashworth, chief North America economist at Capital Economics, which for now still leans towards the Fed raising interest rates by a quarter percentage point.

“It is a very close call … the risk of a full-blown contagion remains, and a lot can happen in the week until the announcement.”