Economists believe the Fed will continue to raise interest rates despite the banking crisis

The Federal Reserve will continue to raise its benchmark key interest rate and keep it above 5.5 percent for the rest of the year, despite turmoil in the US banking sector, according to a majority of leading academic economists polled by the Financial Times.

The latest study, conducted in collaboration with the Initiative on Global Markets at the University of Chicago’s Booth School of Business, suggests the U.S. central bank still has work to do to stamp out stubbornly high inflation, even as it grapples with a crisis among mid-sized lenders after the implosion of Silicon Valley Bank.

Of the 43 economists surveyed between March 15 and 17 — just days after U.S. regulators announced emergency measures to contain contagion and shore up the financial system — 49 percent predicted the federal funds rate would peak between 5.5 percent and 6 percent this year.

That’s up from 18 percent in the previous survey in December and compared to the rate’s current level of between 4.50 percent and 4.75 percent.

Another 16 percent thought it would peak at 6 percent or higher, while about a third thought the Fed would stop at those levels and cap its so-called “terminal rate” below 5.5 percent. Also, nearly 70 percent of respondents said they did not expect the Fed to deliver cuts before 2024.

The policy path projected by most economists is markedly more aggressive than current expectations reflected in the Fed Funds futures markets, underscoring the uncertainty clouding not only the Fed’s interest rate decision on Wednesday, but the course over the coming months.

Traders have been discounting since last Friday how much more the Fed will squeeze the economy due to concerns about financial stability. They are now betting that the central bank will only raise its key interest rate by another quarter of a percentage point before ending its tightening campaign. This would result in a terminal interest rate of just under 5 per cent. They also increased bets that the central bank would quickly reverse course and implement cuts this year.

“Fed is really caught between a rock and a hard place,” said Christiane Baumeister, a professor at the University of Notre Dame. “They have to continue to fight inflation, but now they have to do it against the backdrop of heightened stress in the banking sector.”

Baumeister, who participated in the survey, urged officials against “prematurely” ending their monetary tightening campaign, but called it a “matter of maintaining the Fed’s credibility as an inflation fighter.”

About half of those surveyed said the events related to the SVB had caused them to reduce their forecasts for the Fed Funds rate at the end of 2023 by 0.25 percentage points. About 40 percent were evenly split between the route of no change or possibly more tightening eventually versus half a point for easier policy from the central bank.

A majority believed that the measures taken by government authorities were “sufficient to prevent further bank runs during the current interest rate tightening cycle”.

Jón Steinsson of the University of California, Berkeley was one of the panelists who concluded that the Fed and its regulatory counterparts were succeeding in containing the turmoil, saying it “would be a mistake to change the tightening cycle appreciably”.

The more hawkish stance stems from a more pessimistic view of the inflation outlook.

Most of the economists surveyed expect the Fed’s preferred gauge — the core price index for personal consumption expenditures — to remain at 3.8 percent at the end of the year, about a percentage point lower than the level in January but still well above the central bank’s 2 percent target. . In December, the median estimate for core PCE for the end of 2023 was 3.5 percent.

In fact, nearly 40 percent of respondents said it was “somewhat” or “very” likely that core PCE would still exceed 3 percent by the end of 2024. That’s roughly double December’s share.

Deborah Lucas, a professor of finance at the Massachusetts Institute of Technology who participated in the study, said she has a more benign view of the inflation outlook, but warned that the Fed’s tools were largely ineffective in addressing what she sees as a problem arising from supply. shocks, “aggressive” fiscal policy and increased savings among Americans.

“What the Fed will do if it raises rates too aggressively is it will cut off needed investment and do very little about inflation,” she said.

An ongoing debate is how significant a credit crunch is brewing across the country as the regional banking sector takes hold.

Stephen Cecchetti, an economist at Brandeis University who previously headed the monetary and economic division of the Bank for International Settlements, said he expects to see overall demand “pull back.”

“Financial conditions are tightening without them doing anything,” he said of the Fed.

A slim majority expects the National Bureau of Economic Research — the official arbiter of when U.S. recessions begin and end — to declare one in 2023, with the majority believing it will happen in the third or fourth quarter. In December, a majority thought it would happen in or before the second quarter.

Still, the recession is expected to be shallow, with the economy still growing 1 percent in 2023. Meanwhile, the unemployment rate is expected to rise to 4.1 percent by the end of the year, up from the current level of 3.6 percent. It will ultimately peak between 4.5 percent and 5.5 percent, 61 percent of the economists reckon.