Fed to make decision on interest rate policy amid bank chaos

The Federal Reserve entered 2023 focused on a central goal: wrestling down the rapid inflation that has plagued American consumers since 2021. But over the past two weeks, that job has become a lot more complicated.

Many economists expect central bankers to raise interest rates a quarter-point, to just above 4.75%, on Wednesday, continuing their fight against rapid price increases. A range of investors and analysts had expected the Fed to make an even bigger rate move until a series of high-profile bank closures and government rescues raised concerns about both the economic outlook and financial stability.

On Sunday, the Fed pumped up its program that keeps dollar financing flowing around the world, its second move in a week to shore up the financial system. The previous Sunday, it unveiled an emergency lending program meant to serve as a relief valve for banks that need to raise cash.

Fed Chairman Jerome Powell and his colleagues must now decide how to react to bank turmoil when it comes to interest rate policy, which guides the speed of the economy. And they must do so quickly. In addition to announcing a rate decision this week, Fed officials will also release a set of quarterly economic projections that will indicate how high they expect borrowing costs to climb this year. Central bankers had expected to lift them to roughly 5% in 2023 and, before the market volatility, had hinted they might adjust that anticipated peak even higher in their new projections.

But now, Fed officials will have to make their next move against a backdrop of banking system instability. They could try to balance the risk of lasting inflation against the risk of causing financial turmoil — raising rates more slowly and stopping earlier to avoid fueling more tumult. Or they could try to separate their inflation fight from the financial stability question altogether. Under that scenario, when it came to setting the level of interest rates, the Fed would pay attention to banking problems only inasmuch as they seemed likely to slow down the real economy.

That’s the approach the European Central Bank took last week, when it followed through with plans to raise rates by half a point even as one of Europe’s biggest banks, Credit Suisse, was swept up in the market mayhem.

The range of possibilities makes this the most uncertain central bank gathering in years. During Powell’s tenure, officials have mostly hinted at what they are going to do with interest rates before their meeting, so they do not catch financial markets by surprise and prompt a bigger-than-warranted reaction with their policy adjustment. But there is little clarity as this week begins. Investors were putting 60% odds on a quarter-point increase and 40% odds on no move at all.

Many Wall Street economists expected a quarter-point increase.

“You lose time on the fight against inflation if you wait,” said Michael Feroli, the chief U.S. economist at J.P. Morgan. Still, Feroli had expected the Fed to raise its forecast for how high it would nudge rates this year, and he now expects them to leave their peak rate estimate unchanged at about 5%. But a few thought the Fed would hit pause, including economists at Goldman Sachs.

“While policymakers have responded aggressively to shore up the financial system, markets appear to be less than fully convinced that efforts to support small and midsize banks will prove sufficient,” David Mericle at Goldman Sachs wrote in a preview. “We think Fed officials will therefore share our view that stress in the banking system remains the most immediate concern for now.”