BTFP Compels FOMC to Focus on Price Stability

After vacillating over the last couple of weeks, analysts seem to finally be coalescing around an expectation that the Fed will hike by 25bps at its March meeting as the fight against inflation continues after the Fed stepped in to provide liquidity support.

Fighting Inflation or Saving the Banks

In his press conference following the FOMC's last meeting, Fed Chair Jerome Powell said that a "couple" more rate hikes are coming, leaving the understanding that there would be a 25 bps hike at the March meeting. As the data came in over the subsequent weeks, followed by the collapse of three regional banks, expectations for what the Fed would do fluctuated wildly. The consensus is that the Fed will want to communicate calmly and carry through its plans as a show of confidence, similar to what the ECB did last week. So, a hike of a quarter point would be in line with what the Fed communicated after the last meeting.

The Fed is understood to be trying to separate its support for banks from its fight against inflation. Higher interest rates are putting pressure on banks, which is one of the reasons given by those who believe the Fed won't hike. But the Fed has provided a mechanism to neutralise that effect, called the BTFP, which allows banks to borrow money on treasuries and MBS at par value. Meaning that they won't face a liquidity issue if people withdraw money while they have unrealised losses on bonds, which is the issue that pushed SVB to the brink. The theory is that this should be the mechanism to help the banks, freeing up the Fed to continue its planned hiking to stabilise prices as stipulated in its mandate.

Lining Up Expectations

Over 80% of traders expect the Fed to hike by a quarter of a point on Wednesday, and a vast majority see rates being higher after the next meeting in May. Over the last few days, investors have become more reassured about the banking sector as no new major bank collapses have occurred since the BTFP program was implemented, and an official said that outflows from banks were stabilising.

Investors will likely focus on the post-rate press conference Fed Chair Jerome Powell held. The Fed has been in its pre-rate decision blackout through the entirety of the bank turmoil, and this will be the first time there will be official commentary. Even if JP doesn't volunteer to talk about it in his statement, reporters will definitely ask him. How those questions are handled could set up the market's trajectory after the FOMC meeting. 

USD/JPY Just Completed Wedge Pattern

USD/JPY has recently completed a wedge down at 130.54, likely reversing to correct towards 135.11 through 133.82. Failing to get past the short-term ceiling of 132.77 might bring a shallow correction to an end instead, opening the door to 128.02. If the short-term support at 131.24 gives way to bears, we might see a revisit of the wedge low at 130.54. If not, prices might accelerate again for a bullish outcome or to range until further clarity.

Source: Spreadex / USDJPY

Key Takeaways

80% of traders expect the Fed to hike by 25bps at the March meeting later in the day as the BTFP program has been implemented to support banks facing liquidity issues. Most see rates higher after the next meeting in May, while others expect no hike to save the banks from collapsing.