Fed tilts toward rate hike in May

US Federal Reserve officials remain set to raise interest rates at their May 2-3 meeting but key data between now and then, particularly a survey of bank lending officers, may shape how they weigh the risks facing the US economy and whether they decide to pause further increases.

Since the March 21-22 meeting Fed officials say they have kept in close touch with bank executives and contacts in other industries to gauge how the dramatic collapse of Silicon Valley Bank on March 10 affected the willingness of financial firms to provide credit to businesses and households, and try to gauge if bigger problems threatened.

The increased monitoring has included daily checks on liquidity, Fed officials said, and a drive to be sure all banks had the paperwork ready to borrow quickly from different Fed facilities should it be necessary — signs of how seriously top central bankers viewed the collapse of SVB and the smaller Signature Bank.

However the fallout since then has been muted enough that Fed officials, in their final comments before a pre-meeting blackout period begins on Saturday, have swung their focus back to persistently high inflation and the need for at least one more quarter point interest rate increase.

Overall bank credit did fall about 1.5 per cent in the three weeks from Wednesday, March 15 to Wednesday April 5, and there were initial outflows of deposits from smaller banks to larger ones. But those flows quickly stabilised, and the Fed’s recent Beige Book compendium of observations about the economy showed the lending impact seemingly regionalized, not evolving into an imminent national credit crash.

“There was some turbulence...and it kind of worked itself out,” Atlanta Fed President Raphael Bostic said in an interview with Reuters of the time following the SVB collapse. “Our team started asking bankers lots of questions. Are you seeing deposits leave? Are you getting elevated calls?...There was heightened alert.”

But Bostic said when he asked staff if they’d heard anything out of the norm, the response was “no, we really haven’t.”

Similar comments have come from across the Fed system in recent weeks, with an attitude of wariness and a more intense information flow followed by a sense that the worst problems seem to have been avoided.

Investors in federal funds futures have followed that by raising their own expectation the US central bank will follow through with its tenth consecutive rate hike. The quarter point increase expected at the May meeting would raise the benchmark interest rate to the range, between 5 per cent and 5.25 per cent, that Fed policymakers projected in both December and March would likely be the peak for the current round of policy tightening.

Investors are also betting, in large part, that the next rate hike will in fact be the last one, despite an increasingly muddled situation in which some of the information central to the Fed’s debate won’t be publicly available until after the meeting.

The headline data since the Fed’s last meeting has pointed to developing economic weakness and provided reasons to think inflation will slow. Indeed Fed Board of Governors staff at the March meeting of the Federal Open Market Committee projected a “mild recession” would begin later this year.

At the same time, hiring remained strong through March, and wages continue growing faster than Fed officials feel is sustainable. Inflation remains so persistent across important areas of the service industry that one influential policymaker, Fed Governor Christopher Waller, heads into the meeting having declared progress on inflation “more or less stalled.”

The Fed will receive updated information next Friday on the Personal Consumption Expenditures price index, the metric it uses to set its 2 per cent inflation target. As of February annualised PCE inflation was 5 per cent.

An updated Employment Cost Index will also be released that day, providing a broader view of employer labor costs. The ECI is only released quarterly and includes both worker pay and benefits like healthcare, giving what Fed officials regard as a clearer sense of employment-related cost trends.

The last survey already points to a drop in business investment later this year, and “the risks continue to be weighted towards a larger hit to gross domestic product,” he said. “Banks may not be done tightening lending standards, which will restrict access to credit, hurt business investment, reduce business formation, and weigh on job growth and consumer spending.”