The Fed could finally pull back its aggressive policy this month - but it'd be doing so for all the wrong reasons, DataTrek says

• Talk is growing that the Fed could dial pause rate hikes this month in response to the SVB collapse.
• That would be the wrong response by the central bank, according to DataTrek.
• CPI data Tuesday showed inflation rose to 6% year-over-year in February, less than January's 6.4% change.

The Federal Reserve this month could pump the brakes on monetary policy, but central bankers would be doing so for all the wrong reasons, according to DataTrek Research.

Any policy loosening would largely be driven by the recent turmoil in the banking system, rather than the usual economic indicators the Fed keeps tabs on.

"After waiting a year for the FOMC to pivot to a neutral or even easing rate stance, we finally have some signals that might be close to happening," DataTrek cofounder Nicholas Colas wrote in a Tuesday note. "The trouble is that it is happening for the 'wrong' reasons: sudden uncertainty about the health of the US banking system and the potentially long shadow that this problem creates."

On Friday, regulators closed down Silicon Valley Bank, and shuttered Signature Bank two days later. The Fed took extraordinary steps Sunday in setting up the Bank Term Funding Program, which offers a backstop to struggling financial firms.

Bank stocks endured a historic sell-off on Monday before paring losses Tuesday, while Moody's placed First Republic and Western Alliance both on downgrade watch this week.

Inflation data on Tuesday showed February CPI rose 6% year-over-year, down from 6.4% in January. CPI climbed 0.4% month-over-month, according to seasonally adjusted data, matching economists' forecasts.

The data shows inflation is still cooling, and it could encourage the Fed to hold back on raising rates again this month in light of the banking drama.

Indeed, markets already on Monday were pricing in dramatically higher odds of a pause at the upcoming Fed meeting and even rate cuts later this year. Meanwhile, Treasury yields notched their steepest decline since 2008.

Colas pointed out, however, that lower rates "hurt the Fed's ongoing efforts to reduce consumption and the incremental inflation that it creates."

He added that investors now believe that lower rates are an "unequivocal" good, but markets are clearly struggling with that question in light of the "why" behind the lower rate forecast. Colas pointed to the S&P 500 on Monday finishing basically flat even as yields plummeted.

Goldman Sachs strategists said this week that they no longer expect any rate adjustment from the Fed in March. Top economist Mohamed El-Erian, for his part, said the Fed will be forced to surrender on rate hikes following SVB's failure.