The US Federal Reserve today announced an increase in interest rate by 25 basis points. Once the banking crisis began to worsen, the FOMC meeting in March was seen as a crucial occasion globally. Once banks began to fail and reveal a financial weakness in their books, there were rumblings of a Fed pause.
US stocks are seen rallying after the rate hike announcement on Wednesday with S&P 500 and Nasdaq Composite trading in green. Investors may have interpreted the latest decision as dovish, and they believe the central bank will pause monetary tightening sooner than expected, given the market turmoil caused by recent bank failures.
As investors processed the vaguely anticipated 25ps increase in the Federal funds rate, the yield on the US 10-year Treasury note dropped to 3.51%, closing in on the six-month low of 3.3% reached on Monday.
Prior to today’s hike, a 25 basis point rate increase was expected but later, after Fed Chief Powell seemed hawkish during the Congressional testimony in the first week of March, several industry experts believed that the Fed could raise rates by 50 basis points. In the previous FOMC meeting on January 31–February 1, the Fed increased rates by 25 basis points, bringing the range of the federal funds rate to 4.5%–4.75%.
Fed was faced with the conundrum as to whether to ignore the recent failures of two US banks and concerns about a Swiss bank and hold rates to give the financial system time to stabilise or to focus on combating inflation by raising rates as planned.
The Federal Reserve raised the fed funds rate by 25 basis points to 4.75%-5% at its March 2023 meeting, matching the February increase and pushing borrowing costs to new highs since 2007.
Most investors expected the decision, though some thought the central bank should pause the tightening cycle to shore up financial stability following the failure of three US regional banks and the takeover of Credit Suisse.
The central bank stated that the US banking system is sound and resilient, and that recent developments are likely to tighten credit conditions for households and businesses, weighing on economic activity, hiring, and inflation. Meanwhile, the fed funds rate is expected to be 5.1% this year, the same as last.
The US CPI numbers for February indicate that inflation is declining as expected by the market. By raising rates by 25 basis points, the Fed may be able to stick to its plan of gradual rate increases.
Before beginning up the rate raise exercise again later, the Fed may wish to take a break. In the long run, the effects of pausing without controlling inflation may be even more severe. The Fed will need to make decisions based on newly available facts.