Turbulence prompts Wall Street banks to trim hawkish Fed bets

Goldman Sachs is expecting a pause this week from the US Federal Reserve after a year-long rate increase campaign as Wall Street banks scale back their hawkish expectations in the aftermath of the ongoing global banking turmoil.

Bets of a 50 basis points rate rise at the start of the month following evidence of sticky inflation in a tight labour market and hawkish rhetoric from Federal Reserve chair Jerome Powell have been dramatically altered by the collapse of two mid-sized US banks and troubles at Credit Suisse.

A Swiss-backed takeover of Credit Suisse by peer UBS has helped calm some contagion fears but broader ramifications of the deal are yet to be seen. Across the Atlantic, US regulators and the Fed set up lending programs and brokered deals to support regional banks.

Jan Hatzius, chief economist and head of research at Goldman Sachs, said markets appeared less than fully convinced that efforts to support small and mid-size banks would prove sufficient.

“We think Fed officials will therefore share our view that stress in the banking system remains the most immediate concern for now,” he said.

The US Federal Reserve had set the cash rate at almost zero at the start of 2022.Credit: AP

Goldman expects the US central bank to keep its target rate unchanged in the 4.5 per cent to 4.75 per cent range, compared with its earlier expectation of a 25 basis point rise. Peer Citigroup sees a smaller 25 basis point increase, down from a 50 basis points forecast earlier in the month.

Money markets have increasingly added bets towards a pause.

Barclays has changed its view a number of times. The brokerage started with a 50 basis point rise, then changed to a pause following the collapse of SVB Financial. It now forecasts a 25 basis points rise.

Nomura expects a 25 basis point rate cut at the end of the Fed’s two-day meeting on Wednesday.

Pershing Square’s Bill Ackman said the Fed shouldn’t raise its benchmark rate this week, arguing that the banking crisis had already had the effect of a “meaningful tightening of financial conditions”.

Elon Musk has suggested the Fed drop the rate by at least 50 basis points when it meets this week.Credit: Bloomberg

“We have had a number of major shocks to the system,” Ackman wrote in an extended Twitter post, citing three US bank closures, the pressure on First Republic Bank and the emergency takeover of Credit Suisse.

Elon Musk suggested the Fed drop the rate by at least 50 basis points on Wednesday, writing in response to Ackman’s post. Musk has previously called for the Fed to cut rates, arguing over the weekend that the US central bank was “operating with way too much latency in their data” given recent bank failures.

“We don’t yet know where the losses are for investors in these institutions and what the contagion effects may be,” Ackman wrote. With deposits becoming unstable, “what regional bank is going to commit meaningful capital to new construction or business loans in this context?”

Fed chairman Jerome Powell should make clear a pause is temporary and signal that “his intent is to resume raising rates at the next meeting unless the banking crisis remains unresolved,” Ackman wrote.

‘We think Fed officials will therefore share our view that stress in the banking system remains the most immediate concern for now.’

Jan Hatzius, Goldman Sachs

“This is not an environment into which the @federalreserve should be raising rates and adding additional pressure on the system as financial stability is the Fed’s first responsibility,” he said.

Terminal rate forecasts have also swiftly come down. While some banks still see it approaching 6 per cent, money markets now see it peaking at 4.8 per cent by May.

Meanwhile, the European Central Bank last week pressed ahead with a 50 basis point increase despite calls for a smaller cut or a pause in the face of stresses in the banking sector. Major investment banks now expect the ECB to deliver a 25 basis point rise in May.

The Fed has raised rates by 450 basis points since last March in its fight against inflation.

But even with inflation having seemingly peaked it remains well above the Fed’s 2 per cent target. Consumer price inflation stood at a year-over-year annual rate of 6 per cent in February.

That, along with evidence of a still tight labor market forms the basis for expectations of a rate rise this week.

President Joe Biden maintained confidence in Federal Reserve Chair Jerome Powell, the White House said on Monday, amid criticism about the rate increases the Fed has approved in recent months and its handling of the banking crisis.

Democratic Senator Elizabeth Warren told NBC’s Meet the Press on Sunday that Powell had failed and should not be in his job.

Reuters, with Bloomberg

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