Fed Bets Pared as Goldman Scraps March Hike Call on Flaring Risk

(Bloomberg) — Less than a week after Federal Reserve Chair Jerome Powell opened the door to a re-acceleration in the pace of interest-rate hikes, traders slammed it shut again amid the sudden eruption of financial strains at the US regional bank level.

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Economists led by Jan Hatzius at Goldman Sachs Group Inc. said they no longer expect the Fed to deliver a rate increase next week, citing “recent stress in the banking system.”

Treasury two-year yields dropped 25 basis points to 4.34%, heading for their steepest three-day decline since October 1987, when the Black Monday equities rout stunned markets.

The exodus of depositors from Silicon Valley Bank and Signature Bank late last week showcased a crisis of confidence in the lenders’ assets, spurring US regulators into action Sunday to contain the problem.

The Fed set up a new emergency facility to let banks pledge a range of high-quality assets for cash over a term of one year. Regulators also pledged to fully protect even uninsured depositors at SVB.

While those measures should provide “substantial liquidity to banks facing deposit outflows and to improve confidence among depositors,” Hatzius still pulled his previous call for a quarter percentage point increase at the March 21-22 meeting and said there’s “considerable uncertainty” about the path beyond then.

Yields Tumble

Yields on two-year Treasury notes had surged above 5% last Wednesday, to the highest level since 2007, in the wake of Powell’s signaling that a 50 basis-point rate hike was on the table if upcoming economic reports kept coming in hot ahead of this month’s meeting.

The Fed is now seen as likely to raise rates a quarter point next week, after traders had seen better than 75% odds for a half-point hike last Thursday. The Fed funds rate may peak at about 5% in six months from now, the OIS curve shows, down from a terminal rate of 5.74% priced on Wednesday.

Eurodollar markets moved to bet on two Fed rate cuts for the second half of this year. Swaps traders also reduced their projections for six-month changes in central bank rates across eight major developed-market economies, with Canada and Norway seen holding policy over that time frame.

Flare Up

“We continue to look for a 25 basis-point hike at next week’s meeting,” Michael Feroli, chief US economist at JPMorgan Chase & Co., said in a note Sunday. “Even before the problems flared up in the banking sector, we thought a 50 basis-point move would be ill-advised, and we still think that is the case.”

Moving by a lesser magnitude — or even pausing the tightening campaign — would give Powell and his colleagues more time to assess whether there are further problems to emerge in the banking system. A senior US Treasury official told reporters on a call Sunday that there are some institutions that look like they have some similarities to SVB and perhaps to Signature.

“It may take some time before the full ramifications of SVB’s collapse are apparent,” Tom Kenny and Arindam Chakraborty, economists at Australia & New Zealand Banking Group, wrote in a note Monday. “Front of mind for markets is the risk of contagion, deteriorating risk sentiment and potentially a broader financial crisis.”

Meantime, economic data are still pending. On Tuesday, Fed policymakers will get the latest reading on inflation, with the consumer price index for February due. Economists see the CPI rising 0.4% from the previous month, down slightly from a 0.5% gain in January.

(Updates with Goldman scrapping rate-hike bet)