How will the banking crisis affect the Fed's rate decision?

The continuing turmoil in the global banking sector has hit the risk appetite of investors

The emerging number of cracks in the banking sector will put a check on the rate increase policies of central banks. Reuters
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Financial markets began the week amid escalated volatility despite the news that Swiss bank UBS would acquire Credit Suisse, resulting in risk appetite being sucked from markets.

The shotgun wedding between the Credit Suisse and UBS may have eased worries in the short term, but markets remain under pressure.

The Swiss banking crisis comes after the Silicon Valley Bank debacle from a week ago — and will surely not be the last.

The fallout from SVB — although more insulated compared with the Lehman Brothers’ collapse nearly 15 years ago — is still reverberating across the US banking sector, with First Republic Bank emerging as the next potential failure.

In the days that have followed, the US Federal Reserve and more than 10 US banks pumped $30 billion into the balance sheet of First Republic to keep it afloat.

The continuing turmoil in the global banking sector has raised risk, while the flight to safety amid the doom and gloom resulted in gold — a traditional safe haven — surpassing $2,000 a troy ounce for the first time since March 2022, when Russia invaded Ukraine.

Add this new, developing theme to the existing landscape of central bank policy and inflationary pressures, and markets should be in for a rocky ride through the start of the second quarter.

The emerging number of cracks in the banking sector will put a check on central bank policies to raise rates in a bid to ease liquidity concerns in the market.

Since my previous column two weeks ago, the Fed was expected to introduce a 50-basis point increase at its meeting on March 22.

However, markets are now pricing in with more than 75 per cent certainty that the Fed will deliver a 0.25 per cent increase before signalling a pause in future rate increases for the time being.

This would be a clear shift in policy, a knee-jerk reaction to these latest banking developments, which will, ultimately, batter US dollar-long positions.

Recall that a hawkish Fed keeps US dollar prospects bullish; increasing US rates leads to a stronger dollar.

If the Fed looks to suddenly turn dovish in the short term, this could result in the US Dollar Index, a measure of the value of the greenback against a weighted basket of major currencies, returning to its January channel of between 101.50 and 102.50.

This could be one of the most critical Fed meetings in recent memory — and chairman Jerome Powell’s comments at 10.30pm on Wednesday will clarify the trend for the next few months.

In the UK, the Bank of England is set to meet this week and deliver its policy decision on Thursday at 4pm Dubai time.

And as is the case with the Federal Open Market Committee (FOMC) decision, markets will focus on the need for a pause in rate increases from the Bank of England — similar to the action taken by the European Central Bank last week.

While the ECB did deliver a 50 bps increase, it was the dropping of its forward guidance that suggested to markets that the regulator will adopt a wait-and-watch approach, rather than the hawkish undertones of two weeks ago.

Watch: US Federal Reserve chief warns of 'pain' in reducing inflation

US Federal Reserve chief warns of 'pain' in reducing inflation

US Federal Reserve chief warns of 'pain' in reducing inflation

Also coming up is the US gross domestic product print on March 30, followed by the US personal consumption expenditure print, a key inflation metric, on March 31.

These prints seem slightly less important, with all focus on how the FOMC will approach the recent banking crisis — and how this will affect future interest rate policy.

Gaurav Kashyap is risk manager at Equiti Securities Currencies Brokers. The views and opinions expressed in this article are those of the author and do not reflect the views of Equiti Securities Currencies Brokers

Updated: March 22, 2023, 6:56 AM