Zawya - Will the US Fed take a pause from interest rate hikes amid banking turmoil?

The US Federal Reserve is set to announce its decision on interest rate hikes tonight, but financial experts are split on whether a new round of increase will be delivered, as the ongoing turmoil in the banking sector brings investors and markets on edge.

The Federal Open Market Committee (FOMC) started its two-day meeting yesterday. According to the CME FedWatch tool, the markets are expecting a possibility of a 0.25 percentage-point hike.

However, Goldman Sachs said in a note on Monday that the Fed Reserve may take a pause from monetary policy tightening in view of the turbulence in the financial sector.

"We expect the FOMC to pause at its March meeting this week because of stress in the banking system. 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,” the investment bank said.

The global markets have been on edge following the collapse of two American banks, Silicon Valley Bank and Signature Bank, as well as the rescue of First Republic and Credit Suisse.

The recent turmoil has put a spotlight on high interest rates, with analysts saying that the Fed's campaign to tame surging prices has led to instability in the banking sector.

"The crisis of confidence in Credit Suisse and the failure of two other US banks have validated the fears of contagion across the global banking system,” Vijay Valecha, CIO of Century Financial, told Zawya.

He noted that the Federal Reserve and other central banks, such as the Bank of England, the Bank of Japan and the European Central Bank, have announced coordinated actions to improve liquidity provisions via daily currency swaps. The interventions, he said, demonstrate the “current delicate predicament”.

Given that the economy is “treading on thin ice", Valecha noted that the Fed is not likely to “surprise the fragile market with a bold move.”

“[However] there are concerns that a pause now could result in inflation expectations rising if investors interpret it as policymakers are no longer as committed to bringing inflation down.”

The Fed Reserve has delivered a series of rate hikes since last year in a bid to tamp down soaring inflation.

Early this month, Federal Reserve Chair Jerome Powell said there may be a need to impose a higher rate of increase due to "stronger than expected" economic data.

"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.

Ratings agency S&P had said that banks in the GCC region can manage any contagion risk from the recent bank failures, citing that Gulf lenders’ US exposure is lower than 5% of total assets. Banks in the region also enjoy good funding and liquidity profiles and they are expected to receive government support “in case of need”.