By Yasin Ebrahim
Investing.com -- The Federal Reserve is expected to opt for the "safest" path and meet the market expectations of a quarter-point hike later this week as the risk of a pause causing inflation to reaccelerate is too much too bear just as the current turmoil in banking system sparks uncertainty and the lingering ghosts of the central bank's previous transitory inflation call that dented its credibility continue to linger.
“To go with the market pricing of a hike by 25 basis points is the safest way for the Fed,” Zhiwei Ren, Managing Director and Portfolio Manager at Penn Mutual Asset Management told Investing.com's Yasin Ebrahim in a recent Interview. "I don't think the Fed can have a strong conviction in this market … What do you do when you don't have a strong conviction ... You go with the market expectation," Ren added.
About 80% of traders expect the Fed to hike rates by 0.25% on Wednesday.
The Fed, however, would likely prefer to wait, Zhiwei says, but it doesn’t have the luxury nor the option as it is still on a mission to restore credibility – a central bank’s most valuable asset.
Much of that credibility took a hit following the Fed’s unwillingness to ditch its transitory inflation call. Any action that could cause a reacceleration in inflation, particularly when price pressures remain sticky, would be too much too bear.
“If there's a pause or even cut on rates, and the economy were to reaccelerate, and the CPI (consumer price index) goes up to six or seven percent again, then the Fed is going to face a lot of backlash from the politicians and there's a risk of credibility,” Ren added.
“They made the mistake of calling inflation transitory, so they have wasted some of the political capital,” Ren added “I don't know if they still have more have more political capital to spend at this point.”
Other market participants, however, believe the ongoing turmoil in banks - following the collapse of Silicon Valley Bank, Signature Bank (NASDAQ:SBNY), and Credit Suisse – provides enough reason for the Fed to pause rate hikes, arguing that it won’t derail the Fed’s inflation fight.
“We expect the FOMC to pause at its March meeting this week because of stress in the banking system,” Goldman Sachs said.
A pause in the fight against inflation should “not be such a problem,” Goldman Sachs adds, as bringing inflation back to 2% is a medium-term goal … and “the FOMC can get back on track quickly if appropriate, and the banking stress could have disinflationary effects.”
Beyond the rate decision, the Fed’s summary of economic projections, or “dot plots,” about future economic growth, inflation, unemployment, and rate hikes will come into focus.
The Fed’s most recent projections in December pointed to the peak level of rates reaching a 5% to 5.25% range, or 5.1% at the midpoint, suggesting two further rate hikes.
The current banking turmoil, however, means that the Fed’s rate hike path is far less certain than before the stresses in the banking sector started to emerge. Earlier this month Powell had teed up the idea of a larger rate hike in March.
"The latest economic data have come in stronger than expected, which suggests that the ultimate level of interest rates is likely to be higher than previously anticipated," Powell said earlier this month in prepared remarks for a hearing before the Senate Banking Committee.
Beyond the monetary policy decision and dot plots, Powell’s messaging is expected to serve as an important gauge of whether the bumps in banking sector have eased the Fed’s conviction to fight inflation with higher rates.
“The hawkish or dovish market read may come down to whether Powell focuses more on financial or price stability in the press conference,” Citi said in a note, forecasting the Fed to not only hike by a quarter-point but also upgrade its rate-hike path by another 25-basis-points.