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Federal Reserve expected to raise interest rates 0.25%, investors debate next steps

The Federal Reserve is expected to announce a 0.25% increase in its benchmark interest rate on Wednesday, a move many believe could be the final rate hike of the current cycle.

As part of its most aggressive rate hiking campaign since the 1980s, the US central bank has increased the target range for its benchmark interest rate — the fed funds rate — by 4.75% since March 2022; Wednesday's expected rate hike would take the target range to 5%-5.25%, the highest since September 2007.

After kicking off its latest two-day policy meeting on Tuesday, the Fed will announce its latest policy decision Wednesday at 2 p.m. ET. Fed Chair Jay Powell is set to hold a press conference at 2:30 p.m. ET.

U.S. Federal Reserve Chair Jerome Powell attends a press conference in Washington, D.C., the United States, on March 22, 2023. The Fed raised interest rates by 25 basis points at the conclusion of its two-day meeting on Wednesday, lifting the target range of the federal funds rate to 4.75-5 percent. (Photo by Liu Jie/Xinhua via Getty Images)
U.S. Federal Reserve Chair Jerome Powell attends a press conference in Washington, D.C., the United States, on March 22, 2023. The Fed raised interest rates by 25 basis points at the conclusion of its two-day meeting on Wednesday, lifting the target range of the federal funds rate to 4.75-5 percent. (Photo by Liu Jie/Xinhua via Getty Images) (Xinhua News Agency via Getty Images)

"I believe they will signal they expect to pause," Luke Tilley, chief economist for Wilmington Trust, told Yahoo Finance in an interview. "The data that's come out in wake of the last [Summary of Economic Projections] fits with the median forecast — not to say everyone thinks the same thing — but a lot of statements from FOMC participants point to them wanting to take a pause here."

In March, the Fed's latest set of economic forecasts showed most officials expected interest rates to rise above 5% this year and remain there.

Data from the CME Group showed investors are placing a nearly 95% chance on the Fed raising rates by 0.25% on Wednesday.

Wilmer Stith, bond portfolio manager for Wilmington Trust, told Yahoo Finance he thinks the Fed will want to keep their options open based on recent economic data. Stith pointed to stronger inflation readings — particularly in the services sector — and the latest employment cost index figures as signs the economy remains strong.

"I think they'll use the language to get their point across that we may just have to stay higher for longer and we're not necessarily going to pause," said Stith. "I don't see them saying we're going to pause now. I think the Fed will want to push back against rate cuts that the market has priced in."

The most recent inflation data, the personal consumption expenditures index, showed that when excluding the more volatile costs of food and energy prices rose 4.6% over last year in March. The Fed targets 2% annual inflation.

The employment cost index showed workers' pay and benefits rose 1.2% in the first three months of this year, or an annualized rate of 4.8%, faster than the 1.1% rise in last year's final quarter.

Employee costs have continued to rise, which some economists see as a sign inflation pressures will remain stubborn in the months ahead. (Source: BLS)
Employee costs have continued to rise, which some economists see as a sign inflation pressures will remain stubborn in the months ahead. (Source: BLS)

This week's meeting also comes on the heels of the FDIC's brokered sale of First Republic (FRC) to JPMorgan (JPM) early Monday morning, the latest domino to fall in the bank crisis that has seen four banks collapse sine early March.

JPMorgan CEO Jamie Dimon said Monday the seizure of First Republic puts to rest an excruciating period of panic in the banking system, telling analysts on a call "this part of the crisis is over."

The Fed raised rates back in March amid an even more uncertain backdrop following the failures of Silicon Valley Bank and Signature Bank.

Last month, New York Fed President John Williams told Yahoo Finance in an interview he's watching credit conditions closely amid this bank turmoil, but said he had so far not seen broader impacts on consumer and business spending or other parts of the economy.

"Right now you're not seeing any strong signs of those effects happening, but it's something I’m very much watching for," Williams said.

Wilmington Trust's Tilley, for his part, doesn't see risks from the banking system as clearly in the rearview as Dimon and others.

"I don't think anything has been put to bed because banks are still impaired by losses on long-term securities," said Tilley. "Those unrealized losses are still there and they will affect banks' decisions about lending, and they have to be very cautious."

Results of the Fed's senior loan officer survey — a quarterly report that offers a view into bank lending and credit conditions — will be available to policy makers when they meet, though this data won't be released publicly until after the central bank's meeting.

Federal Reserve Bank of Cleveland President Loretta Mester, a non-voting member of the FOMC, told Yahoo Finance in an interview last month the Fed is closer to the end of its tightening journey than the beginning.

"What we really need to do is we need to make sure that we get that inflation rate on that sustainable downward path. That's my focus," said Mester. "The tightening of credit conditions, either from the Fed or perhaps from banks, tightening their lending standards, that's more of a mechanism for getting that done."

And while Fed officials, notably Powell, have continued to emphasize the need to get inflation to come down above all else, recent turmoil in the banking system likely brings a sooner end to this current rate hiking cycle.

"When the Fed increases interest rates, it exposes any fissures in either the financial markets or the economy. For instance, the recent tightening in monetary policy has contributed to the recent stress in the banking system," wrote Ryan Sweet, chief US economist at Oxford Economics, wrote in a note to clients last week.

"Odds are rising that this will be the final hike of this tightening cycle."

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