How Have Bank Failures Impacted The Outlook For Interest Rates?

In February, the U.S. Federal Reserve raised its target Fed funds rate by 0.25% to a new target range of between 4.5% and 4.75% as it attempts to get inflation under control.

Expectations for the Fed's March meeting decision have swung wildly in the past week amid concerns the failures of U.S. banks SVB Financial Group SIVB, Signature Bank SBNY and Silvergate Capital Corp SI.

President Joe Biden reassured Americans about the stability of the financial sector on Monday morning. However, a growing number of investors appear to believe the market uncertainty may be enough for the Fed to pause its rate hikes this month.

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In response to the banking crisis, the bond market is now pricing in a 35.8% chance of no rate hike in March, according to CME Group. Just 24 hours ago, the market was pricing in a 0% chance of no rate hike.

Prior to the string of bank failures, Bank of America analyst Michael Gapen was anticipating a 0.25% Fed rate hike in March. On Monday, he reiterated that expectation.

"We continue to expect the Fed to raise its policy rate by 25bp at its meeting on March 21-22," Gapen said.

Bank of America has also not changed its previous projections that the Fed funds target range will peak at between 5.25% and 5.5% in June.

"We will remain watchful for signs that financial concerns are spreading as conditions in financial markets can change rapidly, in particular when demand for liquidity is rising and if credit provision is weakening," Gapen said.

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More Rate Hikes Coming? The bond market is now pricing in a 43.9% chance of at least one 0.25% rate hike by June and a 13.1% chance the Fed will actually cut rates by that time. Investors now see a target range of between 4% and 4.25% as the most likely outcome by the end of 2023.

Quincy Krosby, Chief Global Strategist for LPL Financial, said there's a chance the Fed will telegraph its next move sometime this week to reduce the uncertainty.

"This morning, there's a question as to whether the Fed will lift rates at all, or will they announce a pause in the monthly Quantitative Tightening (QT) program. Or both," Krosby said.

"With the Fed now in their 'quiet' period before the meeting, it is possible that an announcement will be telegraphed to markets this week especially if attempts to shore up confidence in the banking system fails."

Former Federal Deposit Insurance Corporation chair Sheila Bair said a Fed pause would have a "settling effect on the markets." Goldman Sachs told its clients on Sunday that it no longer expects a March rate hike but noted "considerable uncertainty" about the Fed's path forward from here.

Benzinga’s Take: Tuesday's consumer price index (CPI) reading is another wildcard for the Fed that could significantly change the outlook for interest rates. If February's CPI inflation reading comes in hotter than expected, the Fed may be forced to continue raising rates or risk losing the ground it has gained on the inflation front.