All eyes on impending Fed decision amid banking sector concerns, market volatility

Expectations on Fed rate decision reverse in days following banking system turmoil

Beginning last year, Federal Reserve officials made their intentions on interest rate hikes abundantly clear: The central bank will prioritize quelling a record period of U.S. inflation at nearly all costs by leveraging data and economic inputs to guide its decision-making process.

However, last week’s dramatic and widely publicized stress placed on the U.S. regional and international banking system could potentially force Chairman Powell’s hand in evaluating alternatives and a need to reverse course in response to rapidly evolving financial conditions. In response to the headlines, yields on the 2Y Treasury note, widely viewed as a proxy for Fed policy expectations, fell more than 50bps last Monday, the largest one-day drop since October 1987.

The below charts represent the markets’ expectations of the target federal funds rate for each meeting date through the remainder of 2023. As of EOD March 7, the market had priced in a 30.6% chance of a 50bps rate increase at March’s FOMC meeting and consensus that the Fed Funds target rate would remain well above 5% by end of 2023.

Last week, however, those expectations dramatically changed due to market volatility and growing sentiment that the Fed will need to change tack and pause its approach. As of EOD March 16, the consensus shifted its expectations of a 71.6% chance of a 25bp hike, with a 28.4% probability of rates remaining unchanged at this week’s meeting. Likewise, the market is now expecting a 75bps decrease in rates from current levels before year-end.

Brent crude falls below $72/bbl, down 13% for the week amid concerns over global economic health

Brent crude futures plummeted last week to December 2021 lows on the heels of concerns surrounding the financial sector and the overall health of the global economy. The weakening marked the sharpest weekly decline for the international oil benchmark this year. While investors remain optimistic about a rebound in Chinese demand and OPEC raising its forecast for the country’s oil demand in 2023, additional factors contributed to the commodity pushing lower, including Saudi Arabia’s energy minister Prince Abdulaziz bin Salman stating that OPEC+ would maintain production cuts through year-end.

(Related insight: Watch the on-demand webinar, "Establishing a World-Class Commodity Hedging program")

The week ahead

The critical FOMC meeting will take place over Tuesday and Wednesday of this week, including a Wednesday decision on whether the Fed will raise rates or pivot to a more dovish footing. Across the Atlantic, the Bank of England will also meet Thursday to decide its path forward on rate increases. An unexpected move could help contribute to FX volatility over the coming days and weeks.

(Related insight: Read, "7 ways to maximize FX and commodity hedging impact while minimizing costs")