CS - Expectations tilt firmly towards 25 bp Fed hike spurred by bank crisis ECB decision

2023-03-16 18:26:00 ET

Market participants on Thursday appeared to have skewed firmly towards a 25 basis point rate hike by the Federal Reserve at its upcoming monetary policy committee meeting.

The recalibration in expectations has been spurred by the recent turmoil in the financial sector and the European Central Bank's (ECB) decision to hike rates by 50 basis points. The ECB's move came amid calls for central banks on both sides of the Atlantic to dial back on policy tightening in light of the banking crisis.

Ahead of the release of the ECB's decision earlier today at 0915 ET, markets were pricing in a 56.8% probability of a 25 basis point hike by the central bank next week, according to the CME FedWatch tool. The probability of no hike was at 43.2%.

After the release of the ECB decision, the probabilities changed significantly and veered further in favor of 25 bps through the day. As of 1745 ET, the probability of a 25 bp hike was nearly 80%, while that of no hike was about 20%.

"The Fed will likely echo the ECB message, indicating that inflation is too high, but will use the tools needed to provide liquidity to distressed banks. This will clear the path for the Fed to raise rates by at least 25 bps and signal more hikes to come," Michael Kramer of Mott Capital Management told Seeking Alpha on Thursday.

Expectations have also skewed towards a 25 bp hike by the Fed due to traders making bets that the central bank would avoid higher rate hikes to protect financial stability in light of the collapse of SVB Financial's ( SIVB ) Silicon Valley Bank and Signature Bank (SBNY). Credit Suisse's ( CS ) troubles have added to the concern.

ECB President Christine Lagarde in her post-policy press conference earlier today stressed that inflation remained too high and that the central bank would continue to take a data-driven approach. When asked about the banking sector, she said that policymakers were "monitoring current market tensions closely" and stood "ready to respond as necessary to preserve price stability and financial stability in the Euro area."

"In the past, the Fed has been crystal clear that the objective is to hit its mandated inflation target of 2%. One can easily argue that there is plenty of liquidity in the overall system, with more than $2T that goes into the Fed's reverse repo facility daily. Now, the new Bank Term Funding Program (BTFP) can also be a source of liquidity if needed for the banks," Mott Capital's Kramer said.

Last weekend the Fed moved to assuage fears over the stability of the financial system in the wake of Silicon Valley Bank's collapse by introducing the BTFP. Under the new program, the central bank would offer loans of up to one year in length to banks, savings associations, credit unions and other eligible depository institutions.

JPMorgan's Nikolaos Panigirtzoglou in a research note on Wednesday said the usage of the Fed's BTFP would likely be big.

"For example, by just looking at the uninsured deposits of the six U.S. banks with the highest ratio of uninsured deposits over total deposits (all six are US regional banks), we come up with $460B," Panigirtzoglou said.

"The higher the usage of BTFP, the higher the injection of reserves by the Fed and the greater the liquidity relief for the U.S. banking system," he added.

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