ETHENEA Commentary: why the Federal Reserve will not pause on interest rate hikes

Volker Schmidt, Senior Portfolio Manager at ETHENEA Independent Investors S.A., differentiates the situation ahead of the Federal Reserve's (Fed's) upcoming interest rate decision on 22 March 2023. Following the bankruptcy of Silicon Valley Bank (SVB) in California, according to Schmidt, forecasting has become much more difficult:

• “On the one hand, consumer prices in the US continue to rise, as the recently published inflation figures for February clearly show: In the previous year, inflation was 6%. This is well above the Federal Reserve's inflation target of 2%. In addition, US core inflation is not declining either. Last week, Fed Chairman Jerome Powell said in congressional testimony that a 50-basis-point increase in the federal funds rate was not out of the question given the still-strong US labour market and strong retail sales. This would represent an acceleration in the rate hike cycle, following the Fed's decision to raise rates by 25bp at its February meeting. The economic fundamentals have changed little since then.
• On the other hand, the insolvency of the SVB has raised the possibility of further bank runs: Further aggressive interest rate moves could complicate the situation of the money houses and make it even more difficult to keep clients from withdrawing their money from the bank. A pause would also be difficult psychologically. If the Fed pauses now, a later return to rate hikes could damage the central bank's credibility.
• On balance, I think it is realistic for the Fed to raise the base rate by 25 basis points to reflect stubborn inflation, solid growth at the beginning of the year and a very robust labour market. With no scheduled Federal Open Market Committee (FOMC) meeting in April, the Fed will have two months thereafter to monitor the macroeconomic impact of the banking problems. The FOMC's role is not to ensure a stable banking system. Rather, its primary objectives are to fight inflation and promote a high level of employment. With inflation well above the central bank's target and employment still very high, there is little reason to stop raising interest rates. Fears of recession are premature, and bank customers need not worry about their deposits. They can move them to safer banks. Suspending rate hikes as a purely precautionary measure would therefore be out of the question.”