UBS's takeover of Credit Suisse has investors divided over the Fed's next move. Here's what the $3 billion deal could mean for US interest rates.

• UBS announced a $3.25 billion takeover deal of the beleaguered Credit Suisse on Sunday. 
• The move builds on a spreading banking crisis, which has already seen the implosions of Silicon Valley Bank and Signature Bank. 
• Investors are now keeping their eyes peeled as to what this means for the Federal Reserve's next interest-rate decision. 

March has been a tumultuous month for financial markets, and it's not over yet. 

The most anticipated event of the month is almost here – the Federal Reserve's monetary policy decision. On Wednesday, Chair Jerome Powell is expected to announce the central bank's next interest-rate move, following a 25-basis-point increase in February and 50-basis-points hike before that to cool inflation. 

At a March 7 meeting, Powell delivered a hawkish testimony where he indicated the Fed was prepared to keep tightening policy as inflation remained stubbornly high and a string of economic data suggested the US economy was too hot. It spurred investors to boost bets for a 50-basis point rate hike this month. 

Banking turmoil

However, such expectations have since been swept aside by spreading turmoil across the global banking sector. On Sunday, UBS announced a $3.25 billion takeover deal of Credit Suisse as part of efforts to contain the crisis. That was followed by joint action from six major central banks to bolster market confidence via fresh measures to ensure easy funding conditions. 

The deal to rescue Credit Suisse follows the implosion of several US lenders, including Silicon Valley Bank, Signature Bank and Silvergate Capital, in recent weeks.

Markets have now scaled back their rate-hike bets in light of the continuing banking jitters, now mostly anticipating a 25-basis-point increase or even a pause versus a 50-basis-point move expected earlier, according to the FedWatch Tool. Top voices like Elon Musk have also suggested the Fed could start cutting benchmark rates.

The yield on the 2-year Treasury note has plunged almost 93 basis points since its March 8 highs, suggesting a U-turn in Fed rate expectations.

Why would European bank woes affect Fed monetary policy? 

For the past many quarters, global central banks have been pursuing joint efforts to curb inflation by tightening monetary policy. While the aggressive rate increases have helped cool price pressures, they've also had some unwelcome side effects. They've dealt a blow to the stock market, the housing sector and now banking. 

A rapid rise in rates tends to hurt demand for loans, threatening banks' profitability. It can also reduce the value of investment assets held, as in the case of Silicon Valley Bank's bond portfolio. 

To raise rates or not to raise rates? 

"The Fed faces an intensified trilemma: how to simultaneously reduce inflation, maintain financial stability, and minimise the damage to growth and jobs. With financial stability concerns seemingly running counter to the need to tighten monetary policy to reduce high inflation, it is a situation that complicates this week's policy decision-making," said top economist Mohamed El-Erian in an Financial Times op-ed, adding that the central bank should avoid keeping rates unchanged and instead, hike them by 25 basis points. 

Meanwhile, Goldman Sachs has ruled out a Fed rate hike at this week's meeting, citing banking-system stress. JPMorgan's chief investment officer of fixed income, Bob Michele, echoed those views. He said the Sunday deal between UBS and Credit Suisse makes it less necessary for the Fed to tighten rates.

"I think the regulators in Europe, and Switzerland, and I think those in the US, when you circle back a week ago, responded with a speed we've never seen before and cut a lot of red tape and stopped this in its tracks… The Fed doesn't have to raise rates on Wednesday. The market's going to do the credit tightening for them," he told Bloomberg.

Nobel Prize-winning economist Paul Krugman holds a similar view.

"The banking mess is, as far as I can tell, sufficient reason for the Fed to pause until we know more," he said in a tweet Monday.

This story was updated at 6:30 a.m. ET to reflect price moves.