The Fed: Will they hike or not?

Economists, money managers, and the market have debated the Federal Reserve’s next move. After months of speculation, a mixed bag of opinions, and even a looming banking crisis, the Fed will convene this week to determine whether to hike interest rates by 25 basis points. Yet, despite a market consensus that believes they will do so, it does not convince many economists and money managers it is the right decision. A recent CNBC Fed Survey found that only 52% believe the Fed should hike, yet 72% expect them to do so. So why is there such a divide?

The risk of financial contagion

One major factor fuelling the argument for the Fed to hold off on hiking rates is the recent failures of Silicon Valley Bank and Signature Bank. In addition, the financial contagion risk is a real concern, with many on Wall Street suggesting the Fed should hold some dry powder in reserve. Over half (52%) of economists and money managers polled by CNBC believe that financial stability is a bigger issue for the Fed now than inflation, and almost three-quarters (72%) rate systemic risk as high.

The Fed’s dilemma

The Fed’s dual mandate of maintaining inflation and financial stability has created a dilemma for Fed Chair Jerome Powell and the FOMC. Can they instill confidence in the market and prevent the economy from a hard landing while keeping financial stability tools separate from their inflation-fighting monetary policy tools? The risk is that these forces will overlap, with a banking crisis leading to tightened credit at banks and creating enough disinflation to slow the economy.

The data problem

The Fed’s decision-making process is heavily reliant on data. However, there hasn’t been enough evidence to suggest the fight against inflation has progressed to the point where confidence in credit tightening can do the disinflation job without a rate hike. While wage growth has cooled, it remains strong, job growth is running at a hotter pace than expected, and recent revisions show that progress in bringing prices down hasn’t been quite as good as the initial data suggested.

Key takeaway

The Fed’s decision to hike rates is complex, and it’s clear that even the experts are divided. While the market seems to believe that a hike is imminent, many economists and money managers are not convinced it’s the right decision. Moreover, the risk of financial contagion, the dilemma facing the Fed over balancing inflation and financial stability, and a lack of clear data all add to the situation’s complexity.

Related facts

• According to a recent CNBC Fed Survey, only 52% believe the Fed should hike rates, yet 72% expect them to do so.
• Over half (52%) of economists and money managers polled by CNBC believe that financial stability is a bigger issue for the Fed now than inflation.
• Almost three-quarters (72%) rate the level of systemic risk as being high.

Conclusion

At this stage, it’s impossible to predict exactly what the Fed will decide to do. However, any decision will come with risks and trade-offs. For example, the Fed may hike rates to curb inflation, but this could lead to tighter credit, financial contagion, and potential disinflation. On the other hand, not hiking rates could lead to stagflation and a greater cost to society. Therefore, the Fed’s decision should be two-fold: explain their powerful financial stability tools and hike rates by 25 basis points if they see it as necessary.