San Francisco Frontiers - SVB collapse causes headaches for US Fed before rate decision

Traders and analysts who had previously predicted that the Fed would increase the pace of hikes to tackle inflation have now dialed back their expectations, with some saying the US central bank will hold its benchmark rate next week due to the troubles in the banking sector.

Last week's collapse of SVB and New York-based Signature Bank marked the biggest banking failures since the 2008 global financial crisis.

It has left the Federal Open Market Committee (FOMC) in an unenviable position as it looks to tackle above-target inflation and hot economic data without adding to the ongoing rout of some banking stocks.

Analysts at Goldman Sachs and Wells Fargo now predict the Fed will end its hiking cycle on March 22, while economists at JP Morgan and Oxford Economics see the FOMC voting for a smaller quarter-percentage-point hike.

- Reducing contagion -

America's top finance officials unveiled a series of measures over the weekend aimed at restoring confidence in the banking sector and settling turbulent markets.

The Treasury, Fed, and Federal Deposit Insurance Corporation set out plans to ensure SVB's customers would be able to access all their deposits in the bank.

Signature Bank would also be "made whole", they said in a joint statement on Sunday.

The Federal Reserve also introduced a new lending tool for banks to try and prevent a repeat of SVB's swift collapse, when a bad financial report led concerned customers to rapidly withdraw their funds, causing a liquidity crisis.

But while the US has moved to protect customers' deposits, it won't be bailing out the bank's investors, President Joe Biden told reporters on Monday.

"They knowingly took a risk and when the risks didn't pay off, investors lose their money. That's how capitalism works," he said.

- 'Uncertain' situation -

Sunday's announcement was well received by the financial markets, with the Nasdaq closing up 0.45 percent on Monday.

But investors continued to shun banking stocks on Monday, and analysts remain concerned about the broader fallout from SVB's collapse.

"The rapid tightening in financial conditions alongside the uncertainty of the situation makes us lean toward the FOMC taking a pause from its hiking campaign at its upcoming meeting on March 22," Wells Fargo economists wrote in a recent note to investors.

Those leaning towards a 25-basis-point hike next week, such as JP Morgan's Michael Feroli, said the Fed should be able to tackle both the uncertainty in the financial markets and above-target inflation.

"If they indeed have used the right tool to address financial contagion risks (time will tell), then they can also use the right tool to continue to address inflation risks -— higher interest rates," he wrote to clients on Sunday.

- A 'close call' -

As recently as Thursday, futures traders were predicting a return to a 50-basis-point rise, according to CME Group's FedWatch Tool.

The expectations of a larger hike solidified after Fed Chair Jerome Powell warned on Wednesday that the US central bank was prepared to increase the pace of interest rate hikes in the face of "widespread" inflationary pressure.

But SVB's failure in the days that followed changed the calculus among traders.

The probability of a larger hike fell to zero on Monday, with most interest-rate futures traders now predicting a smaller hike, and a minority expecting no hike at all, calculated CME Group.

Growing concerns about the stability of the US financial markets means a 25-basis-point hike is now "slightly" more likely next week, Oxford Economics Lead Analyst John Canavan wrote in a note to clients on Monday.

"We have for now maintained our expectation for a 25bp hike at the March meeting but see this as a close call," Deutsche Bank economists wrote to clients on Monday, adding they would finalize their views "after observing this week's developments."

M.Gonzalez--SFF