The Federal Reserve is poised to push its benchmark interest rate above 5% for the first time in nearly 16 years, while mounting recession fears and ongoing turmoil in the banking sector will likely fuel debate among central bank officials about where rates are headed.
Investors overwhelmingly believe Fed Chair Jerome Powell will announce a 25-basis-point increase on May 3, pushing the Fed funds rate to a range of 5.00% to 5.25%, according to May 1 data from the CME FedWatch Tool, which measures sentiment in the fed funds futures market. That would push the rate above 5% for the first time since August 2007 and mark 500 basis points in rate hikes since March 2022, the most aggressive rate-hike push in Fed history.
However, the upcoming decision by Federal Open Market Committee members is unlikely to be unanimous, given concerns that more rate hikes could worsen a potential recession and increase stress in the banking sector. The Fed's last rate increase came just days after the collapse of Silicon Valley Bank, which fueled speculation that the central bank could pause rate hikes or even signal rate cuts. This week's meeting follows the failure and takeover of First Republic Bank.
"I'd be shocked if there was another unanimous decision to hike rates," said Callie Cox, a US investment analyst at eToro. "I was shocked at the last meeting that nobody dissented given what had happened in the banking system. The Fed did set the table for more flexible policy at that meeting, so they have more leeway to pause or change rates this time around."
Recession tradeoff
Fed officials believe that stress in the banking sector is likely to push the US into a mild recession later this year, according to the minutes of the Fed's March meeting. Still, those recession fears are likely not enough to knock the Fed from its rate-hike plans.
"Fed officials would ideally like to avoid a recession, but they're more focused on getting inflation back to 2%," said Oren Klachkin, lead US economist with Oxford Economics. "Fed officials won't explicitly say it, but I think they'd take that tradeoff if it meant inflation will return to its pre-pandemic run rate."
In March, personal consumption expenditures excluding food and energy grew to 4.6% from March 2022, the US Bureau of Economic Analysis reported on April 28. That number, while down from the peak of 5.4% annual growth in March 2022, remains well above the Fed's 2% target.
In addition, the Fed's rate hikes have failed to cool the labor market, with wage growth remaining high and unemployment still near the lowest levels in about 60 years.
"The Fed is aware of the risk or potential likelihood that its policy tightening will cause a recession," said Michael O'Rourke, chief market strategist at JonesTrading. "That said, it is far more important to get inflation under control. If inflation remains persistent for too long, businesses will lose confidence in pricing forecasts and be cautious on spending and investment."
'Tough needle to thread'
In his press conference after this week's meeting, Powell is likely to say that the Fed's next moves will depend on the data, and he will likely signal that a pause in hikes is possible, said James Knightley, chief international economist with ING.
"However, I think they will be reluctant to signal that cuts are on the agenda for later in the year as this would be viewed very 'dovishly' by markets and give the all clear for the dollar to sell off and Treasury yields to plunge, which would undermine their efforts to tame inflation," Knightley said.
For now, the Fed will continue to try to calm inflation, not overly pressure the jobs market and attempt to avoid a recession, at least a significant one.
"It's a tough needle to thread, but that's the intention," said Cox with eToro. "While the economy is weathering rate hikes well and inflation is moving in the right direction, the margin of error gets thinner every day."