Case for Fed Pause Builds After Crisis-Echoing Move on Swaps

(Bloomberg) — The case for the Federal Reserve to forgo an interest-rate hike strengthened in the eyes of some central bank watchers following a coordinated global move to ease growing financial strains.

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Ahead of the weekend, most economists had been forecasting that the Fed would raise its benchmark rate by a quarter percentage point on Wednesday, to a range of 4.75% to 5%, extending a yearlong campaign to stamp out inflation.

On Sunday afternoon, however, the Fed and five other central banks announced action to boost liquidity in US dollar swap arrangements by increasing the frequency of access to daily from weekly — echoing actions taken during other moments of crisis.

While US stock futures and Treasury yields climbed in the initial hours of trading following Sunday’s news, and investors increased bets on a quarter-point hike, several analysts said the risk-benefit calculations around a pause were becoming more favorable to such an option.

“The fact that you are engaged in global coordination with other central banking authorities to rescue institutions and keep liquidity flowing, it just suggests that a pause is probably a better risk/reward,” said Julia Coronado, president of MacroPolicy Perspectives LLC and a former Fed economist.

The central bank could signal that its “intention right now is focused on stabilizing the liquidity in the banking system,” she said.

The latest news followed UBS Group AG’s agreement Sunday to buy Credit Suisse Group AG in a government-brokered deal aimed at containing a crisis of confidence that threatened to spread across global markets.

And it all came on the heels of the collapse of three US lenders a week ago, developments that effectively took a 50 basis-point hike — something floated by Chair Jerome Powell earlier in the month — off the table.

The Fed was joined by the Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank and the Swiss National Bank in announcing the coordinated action.

As Asian markets digested a frenetic weekend of global banking developments Monday morning, equities dropped across the region. Additional tier-1 bonds issued by some Asian banks fell by a record during Asian trading hours. A Swiss regulator earlier said $17 billion of such AT1s from Credit Suisse would be wiped out.

Contagion Concern

To be sure, the decision on whether to pause or hike remains a tough call, and analysts weren’t immediately changing their predictions, so much as indicating that the chances of a pause seemed to have increased following Sunday’s developments.

The various actions on Sunday “suggest greater worry about the left-tail risk from financial contagion, and on the margin could put (our presumption of) a rate hike by the FOMC on Wednesday in a bit more doubt,” former Fed governor Laurence Meyer and his colleagues at research firm Monetary Policy Analytics said in a note Sunday night.

“The higher risk of pausing also suggests higher risk that the FOMC would revise downward or suspend balance sheet runoff, especially if policymakers think recent stress sends a definitive signal of reserve scarcity at the aggregate, systemic level rather than only at the level of individual banks,” they wrote.

Others, like Vanessa Chan, head of Asian fixed-income investment directing at Fidelity International, read the latest move on swaps as potentially boosting the chances that the Fed will have room to separate their focus on price stability from financial stability.

“Interest-rate hikes are probably likely to continue while they start to put in various liquidity instruments or liquidity buffers so it helps to stabilize the sort of liquidity situation that we’re facing in the market,” Chan said from Hong Kong on Bloomberg Radio Monday morning.

Clinging to a forecast of a quarter-point hike this week, DBS Bank Ltd. Chief Economist Taimur Baig also recognized that the conviction of that call is fading.

“A very clear and credible central bank may be able to pull off the balancing act of fighting inflation through higher rates and accommodating liquidity to stem financial market duress,” Singapore-based Baig said in a report Monday. “The Fed is up to the task, in our view, but uncertainties are sky-high, presently.”

Even as Fed officials have repeatedly signaled their intention to keep up the inflation fight by continuing rate hikes, market volatility over the next two days could set them off that course by tightening conditions for them.

“It’s a nuanced message, but hopefully monetary policy is the focus on inflation and all these other tools and measures to sort of stabilize the banking system are separate,” Brad Gibson, Melbourne-based AllianceBernstein head of Asia-Pacific fixed income, said on Bloomberg Television Monday. “But it’s going to be a tough message to sell in a market like this.”

Data released Thursday showed banks in the US borrowed a record amount from Fed backstop facilities in the week ended March 15, topping a previous high reached during the 2008 financial crisis and signaling widespread funding strains.

Fed officials start a two-day meeting on Tuesday. With inflation holding firm and the labor market still hot early this year, some policymakers including Powell had suggested it may be appropriate to re-accelerate the pace of rate increases to a half-percentage-point hike from the 25-basis-point pace officials delivered the last time they met on Feb. 1.

But that was before Silicon Valley Bank’s failure and the resulting market turmoil.

A 25 basis-point hike was “still our base case,” Evercore ISI analyst Krishna Guha, a former New York Fed staffer, said in a note Sunday evening. “But the FX swap flags US global concerns and if we were to see a severe adverse reaction in European financials to the news this could stop out a hike.”

–With assistance from Michelle Jamrisko and Malcolm Scott.

(Updates with additional market developments, comment throughout.)