"To have now this juxtaposition of still very high inflation on the one hand and then at the same time having these emerging financial stability challenges on the other, it makes the job that is already challenging even more challenging," said Antulio Bomfim, head of global macro at Northern Trust Asset Management's global fixed-income team.
Prior to joining Northern Trust in October, Mr. Bomfim served in senior roles at the Fed, including as special adviser to Chairman Jerome H. Powell and special adviser to the Fed Board of Governors.
The committee "will be paying attention to the market dislocations, but they don't want investors out there to think that this will somehow detract them from the single problem that they had a little more than a week ago, which was too high inflation," Mr. Bomfim added.
The Fed will announce on Wednesday whether it will raise rates for the ninth consecutive meeting. The federal funds rate now stands at a range of 4.5% to 4.75% and was last raised 25 basis points in February. That move followed a 50-basis-point increase in December, and four 75-basis-point hikes in each of the committee's previous four meetings.
But with the collapse of Silicon Valley Bank and other ripples in the banking sector earlier this month, the Fed may alter its planned rate-hiking course, Mr. Bomfim said.
"To me, in the near term, maybe they slow the pace," he said. "If they were thinking 50 basis points, maybe they go to 25 basis points. If they were to pause, which doesn't seem likely, it would be accompanied with some pretty explicit language that would say this is a pause while they're assessing evolving dislocations in the market, but they remain highly concerned about inflation."
The last thing the Fed wants after its announcement is for the market to perceive that the central bank is equivocating on its focus on inflation, Mr. Bomfim said. "High inflation to them is really a threat to their credibility as an institution," he added.
According to the CME FedWatch Tool that tracks trading in the 30-day fed funds futures, traders as of Monday afternoon were pricing in a 74.5% chance of a 25-basis-point hike at the Fed's meeting this week and a 25.5% chance of no rate hike.
Prior to the SVB collapse and after Mr. Powell's testified before Congress on March 7 and 8, traders thought there was a 77.1% chance of a 50-basis-point hike at this week's meeting.
Mr. Powell has said multiple times that the Fed will keep raising rates until inflation is reined in. "Restoring price stability is essential to set the stage for achieving maximum employment and stable prices over the longer run," he said before the Senate Banking Committee on March 7. "The historical record cautions strongly against prematurely loosening policy. We will stay the course until the job is done."
Investors should take Mr. Powell at his word, Mr. Bomfim said. "To think that, for example, that they're going to turn from an aggressive position against inflation to now go easier on inflation while they're addressing (stress in the banking sector), I think that'd be an unwise position to have that type of thought," he said.