After the European Central Bank (ECB) announced a 50 bps rate hike as planned, there is a sign that Fed will likely raise rates in upcoming FOMC meet, as both stay on track to tame inflation. However, rate expectations have been rapidly quivering over the last few weeks. As of Friday, there was about a 75 percent likelihood that the Fed will lift rates by 25 bps, CME's FedWatch Tool showed. The remaining 25 percent probability is of policymakers taking a step back from the aggressive tightening campaign that began just over a year ago. Jerome Powell, Fed Chair in his speech in start of this month said “the fight to bring down inflation continues”.
But the story does not end with inflation. The recent events spurred panic in most banking scrips, prodding President Joe Biden’s administration to call for tough penalties on bank executives. His actions to ensure depositors can access their funds in Silicon Valley Bank (SVB) and Signature Bank, should give Americans confidence that the US banking system was safe. Due to the current setback in the banking system, a consensus says that there could be a pause on more rate hikes. Goldman Sachs and Barclays say it no longer expects the Fed to deliver a rate hike at the end of its two-day policy meeting on March 22.
The other camp says there is no reason for the Fed to change track merely due to the SVB crisis. Madan Sabnavis, Chief Economist at Bank of Baroda says “The FOMC is trying to control inflation and hence, stop raising interest rates is not a logical solution to the current SVB crisis. The ECB had raised rates by 50 bps notwithstanding these developments and I would expect the Fed to go ahead with not just the 25 bps hike this time, but also not change their commentary and stance.”
Due to the collapse of Credit Suisse, a globally systemic important bank, there is greater nervousness in the financial markets and its fallout can ripple throughout the entire financial system. But UBS agreement to buy Credit Suisse will restrain the loss of confidence in global banking system.
What is the risk for the Indian banking sector?
Experts say Indian banking sector will be largely unaffected by these events, albeit Indian bankers need to be watchful. Sabnavis says “the quality of regulation has been prudent here all the time. What also provides solace is the inherent strength of the banks which is revealed by parameters like NPA, capital adequacy and profit. This said all banks will be watchful of developments across banks in USA and Europe, to see if there are any meltdown effects at the micro level, given that several banks have subsidiaries operating in these geographies.” He adds “there are lessons to be learnt and warning signals to be picked up especially as Credit Suisse was already embroiled in a controversy on the quality of lending.”
High interest rates in the major developed economies should not be a cause of worry for the global financial system as banks have been actively adjusting their loan books, deposits and investments accordingly. Therefore this does not bring an element of surprise here.
Fed decision today evening will be a big cue for the day as its officials need to take a tough call, whether to continue to fight inflation by raising interest rates or take a pause amidst an intense ongoing banking crisis. Worries over the banking crisis have lately boosted demand for traditional safe-havens such as gold.
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