The Federal Open Market Committee interest rate decision is always important, but the one on Wednesday at 2 pm ET is particularly consequential. In just two weeks, there has been one of the fastest shifts ever in expectations about where the Fed and interest rates are heading. The biggest banking crisis since 2008-9 has shifted expectations about the economy and interest rates.
A little over two weeks ago, there was an 80% chance that the Fed would raise rates by 0.5% today and hike rates a few more times by a quarter point. It was not expected that there would be any rate cuts in 2023.
Following the banking crisis, it is now expected that the Fed will raise rates by 0.25% today and then a 50/50 chance of another hike at the meeting on May 3, but after that, expectations are for a pause and cuts later in the year.
The banking crisis has caused a very abrupt shift in expectations about the economy. It is now expected that the problems at banks will lead to tighter lending standards and make a recession more likely. A recession means there is unlikely to be the severe inflationary pressure that was of so much concern to the Fed.
The market will be intently focused today on how the Fed forecast has shifted. Will there still be concern about employment-driven inflation? Will the banking crisis be the basis for a more dovish Fed? Is the market correctly anticipating where the Fed is headed?
What makes the situation even more difficult is that the market has enjoyed a very energetic rally despite the banking crisis. The S&P 500 has recovered almost all of the losses triggered by the blowup of Silicone Valley Bank (SIVB) , and the Nasdaq has done even better.
Part of the rally has been driven by the creation of trillions of dollars in new liquidity to deal with banks' balance sheet problems. Federal agencies have moved very quickly to shore up confidence in the banking sector, and a big part of that is giving banks access to the cash they need to cover withdraws.
Technically, conditions are very ripe for a sell-the-news reaction to the Fed decision today, but it is almost too obvious. The real question is whether the high level of liquidity will provide some solid support even if the Fed is not market-friendly.
It should be quite dramatic, but the action will be dead until the decision is announced at 2 pm ET and the Powell press conference starts 30 minutes later.