Some investors worry that the Federal Reserve will have a difficult time using tools to fight inflation and calm the banking system. The Fed begins its second meeting on Tuesday morning, and is expected to raise interest rates again. Futures markets are pricing in more than an 80% chance the central bank will raise interest rates Wednesday by a quarter point. At the same time, the Fed has used its balance sheet and other tools to help the banking sector since the failure of Silicon Valley Bank. The Fed is in a tough spot. During the financial crisis and again in the Covid pandemic, it saved the financial system by reducing interest rates to zero. Now, it faces persistently high inflation and is considering yet another rate hike — a tool that could ease rising prices but add pain to the banking system. The fed funds rate range currently stands at 4.5% to 4.75%, an increase from zero to 0.25% in just one year. “Unfortunately, we do not believe that the FOMC has any good options available. If they hike, they will risk financial instability,” wrote Wolfe Research. “If they stand pat, they will fall even further behind the curve in inflation – which is the root cause of the current problem!” Citigroup strategists have similar concerns about the central bank’s actions more broadly. “The idea that monetary authorities can fight inflation and monetary instability together with different tools does not work well,” he wrote in a note. Inflation also damages the economy. Rising prices of goods and services erode household savings and force businesses to seek cost savings. Goldman Sachs economists are among several who expect the Fed to refrain from hiking Wednesday because of concerns about the banking system. “While policymakers are responding aggressively to support the financial system, markets appear less confident that efforts to support small and medium-sized banks will be sufficient,” he wrote. “We think Fed officials will therefore point out that stress in the banking system remains their most immediate concern today.” Federal regulators helped backstop depositors at failed Silicon Valley Bank and Signature Bank this month. The Fed also provides loans to banks for up to a year with lower terms. Ethan Harris, head of global economic research at Bank of America, wrote in a note that he had been surprised at how “shock-free” the Fed’s hiking cycle had been – until recently. “In the summer of last year they moved to one of the fastest hiking cycles in history. Given this shift, and the simple law of large numbers, it seems surprising how uneventful the Fed’s tightening cycle has been … until a week or so ago,” he wrote . “Indeed, part of our baseline view is that some tighter financial conditions – and a mild recession – may be needed to get inflation back to target.”