Just two weeks ago, Federal Reserve officials hinted that they might consider a large half-point interest rate hike at the end of their meeting on Wednesday as the economy shows continued momentum.
A string of bank failures since then not only convinced Wall Street investors and economists that policymakers would raise borrowing costs by just a quarter point on Wednesday – some questioned whether the central bank would raise them at all.
Investors are heaviest bet on a quarter-point increase, but forecasts the possibility that the Fed will drop its steady campaign to raise borrowing costs to contain rapid inflation. Goldman Sachs economists think it's likely that central bankers will hold off on moving interest rates this month, before resuming them in May.
This Fed decision carries very high stakes. If investors believe that central bankers are not sufficiently used to the turmoil gripping the banking industry, nervous markets could back down. Yet if officials halt their rate hikes to let the frenzy go, they are likely to give up their fight against still-rapid inflation.
Jerome H. Powell, Fed chairman, will have the opportunity to explain his latest Fed rate decision and economic projections — scheduled for their first update since December — at a 2:30 p.m. Eastern news conference following the release of the previous half-hour decisions and projections. Mr. Powell may need to work his way up as he balances stubborn inflation with the banking industry's ongoing problems. Here's what to watch for, and why the meeting will be so packed.
Further rate hikes could put pressure on banks.
Silicon Valley Bank's failure on March 10 was partly related to the recent moves in Fed rates: The bank has many long-term securities that have become less valuable as interest rates have risen. The loss helped scare off depositors and sparked a bank run that led to a bank collapse.
The question for the Fed is whether the bank's demise is an isolated example of a company not planning well enough to raise borrowing costs, or a sign that the central bank's fastest rate hike since the 1980s has pushed the financial system to a breaking point. .
Inflation remains a big challenge.
The Fed raised interest rates for a reason: Inflation is high, and it's not going away quickly. Consumer prices increased by 6 percent year-to-date through February, and while annual inflation has slowed, monthly gains have only recently picked up again. The bumpy progress has come just as the broader economy is proving more resilient than expected.
Strong momentum in prices and the labor market would normally spur more aggressive Fed rate moves, but bank turmoil is a complication: If smaller banks lend less in a turmoil, it can itself slow down the economy.
Tariff projections could be key.
Given the uncertainty, the Fed's economic projections could be a focal point. Central bank released the forecast once every three months, offering a snapshot of how officials expect unemployment, inflation and interest rates to develop.
Fed officials are widely expected to push back their forecasts for how high interest rates will rise by the end of 2023 – estimates that were above 5 percent in December. Whether that peak rate forecast will move in the latest projections is now less certain.
Some economists – including Diane Swonk at KPMG – think the Fed may scrap economic projections altogether at this meeting, given the uncertain backdrop. But if they do provide forecasts, it will offer insight into how much beat officials expect the economy to take from the banking crisis. Economic estimation must be submitted the Friday before the meeting, but officials can change it to Tuesday night.