The Federal Reserve entered 2023 focused on a central goal: wrestling down the rapid inflation that has plagued American consumers since 2021. But over the past two weeks, that job has become a lot more complicated.
Many economists expect central bankers to raise interest rates a quarter-point, to just above 4.75 percent, on Wednesday, continuing their fight against rapid price increases. A range of investors and analysts had expected the Fed to make an even bigger rate move until a series of high-profile bank closures and government rescues raised concerns about both the economic outlook and financial stability.
On Sunday, the Fed pumped up its program that keeps dollar financing flowing around the world, its second move in a week to shore up the financial system. The previous Sunday, it unveiled an emergency lending program meant to serve as a relief valve for banks that need to raise cash.
Jerome H. Powell, the Fed chair, and his colleagues must now decide how to react to bank turmoil when it comes to interest rate policy, which guides the speed of the economy. And they must do so quickly. In addition to announcing a rate decision this week, Fed officials will also release a set of quarterly economic projections that will indicate how high they expect borrowing costs to climb this year. Central bankers had expected to lift them to roughly 5 percent in 2023 and, before the market volatility, had hinted that they might adjust that anticipated peak even higher in their new projections.
But now, Fed officials will have to make their next move against a backdrop of banking system instability. They could try to balance the risk of lasting inflation against the risk of causing financial turmoil — raising rates more slowly and stopping earlier to avoid fueling more tumult. Or they could try to separate their inflation fight from the financial stability question altogether. Under that scenario, when it came to setting the level of interest rates, the Fed would pay attention to banking problems only inasmuch as they seemed likely to slow down the real economy.
That’s the approach the European Central Bank took last week, when it followed through with plans to raise rates by half a point even as one of Europe’s biggest banks, Credit Suisse, was swept up in the market mayhem.
The range of possibilities make this the most uncertain central bank gathering in years: During Mr. Powell’s tenure, officials have mostly hinted at what they are going to do with interest rates ahead of their meeting so that they do not catch financial markets by surprise and prompt a bigger-than-warranted reaction with their policy adjustment. But there is little clarity as this week begins. Investors were putting 60 percent odds on a quarter-point increase and 40 percent odds on no move at all.
Many Wall Street economists expected a quarter-point increase.
“You lose time on the fight against inflation if you wait,” said Michael Feroli, the chief U.S. economist at J.P. Morgan. Still, Mr. Feroli had expected the Fed to raise its forecast for how high it would nudge rates this year, and he now expects them to leave their peak rate estimate unchanged at about 5 percent. But a few thought the Fed would hit pause, including economists at Goldman Sachs.
“While policymakers have responded aggressively to shore up the financial system, markets appear to be less than fully convinced that efforts to support small and midsize banks will prove sufficient,” David Mericle at Goldman Sachs wrote in a preview. “We think Fed officials will therefore share our view that stress in the banking system remains the most immediate concern for now.”
And at least one or two anticipated an outright rate cut in response to the upheaval, as the central bank waits to gauge the severity of the economic and financial fallout.
The bout of banking unrest is likely to weigh on the economy, meaning that the central bank itself does not need to do as much to restrain economic growth. The Goldman economists estimate that the impact of the banking crisis could be equivalent to as much as half a percentage point of central bank interest rate increases.
Underlining how uncertain such forecasts are, though, Torsten Slok, the chief economist at Apollo, estimated that tightening lending standards and other fallout from the past week would be roughly equivalent to a more drastic 1.5 percentage point increase in the Fed’s main policy rate.
“In other words, over the past week, monetary conditions have tightened to a degree where the risks of a sharper slowdown in the economy have increased,” Mr. Slok wrote in an analysis over the weekend.
It is unclear how long any pullback in banks’ willingness to lend money will last, or if it will stabilize or worsen. Given the vast uncertainty, Diane Swonk, the chief economist at KPMG, said officials might scrap their economic projections altogether, as they did at the outset of the coronavirus pandemic.
Releasing them would “add more confusion than clarity, given that we just don’t know,” Ms. Swonk said.
Mr. Powell will hold a news conference on Wednesday after the release of the Fed’s post-meeting statement, one that could be tense for a number of reasons: Mr. Powell will most likely face questions about what went wrong with the oversight of Silicon Valley Bank. The Fed was its primary regulator, and was aware of issues at the bank for more than a year before its crash.
And Mr. Powell will have to explain how officials are thinking about their policy path at a complicated juncture, when the Fed will have to weigh economic momentum against blowups in the banking sector.
Hiring has stayed very strong in recent months: Employers added more than 300,000 jobs in February, after more than half a million in January. Officials had expected hiring to slow substantially after a year when rapid interest rate increases pushed borrowing costs to above 4.5 percent in February, from near zero last March, the fastest pace of adjustment since the 1980s.
Inflation, too, has showed unexpected stickiness. While the Consumer Price Index has been slowing on an annual basis for months, it remained unusually rapid at 6 percent in February. And a closely watched monthly consumer price measure that strips out food and fuel, the prices of which bounce around, picked back up.
Economists at Barclays suggested that the incoming data would probably have prodded the Fed to opt for a larger half-point rate increase, all else equal. But given the continuing bank problems — and the fact that Silicon Valley Bank’s distress was partly tied to higher interest rates — they expected the Fed to move by a quarter-point at this meeting to avoid further unsettling banks.
“The link between the rising funds rate and risks of further bank distress presents a clear tension for the F.OM.C.,” the economist Marc Giannoni and his colleagues wrote, referring to the Fed’s policy-setting Federal Open Market Committee. “Risk management considerations will warrant a less aggressive policy hike in March.”
The economists noted that if the situation in the American banking system were not so closely tied to rising rates, Fed officials would most likely prefer to separate financial stability concerns from their fight against inflation.
That is essentially what the European Central Bank chose to do last week. Officials there are also battling rapid inflation, and they are behind the Fed when it comes to raising interest rates, having started later. Their decision to raise rates a half-point came even as Credit Suisse fought for its life, prompting the Swiss government to arrange on Sunday a sale of the bank to UBS.
“This is not going to stop our fight against inflation,” Christine Lagarde, the president of the European Central Bank, said in a news conference on March 16. She added that officials “don’t see any trade-off” between pushing for price stability and financial stability, and that central bankers had separate tools to achieve each.
That sort of message could be one the Fed wants to emulate, Mr. Feroli, of J.P. Morgan, said. Yet there are key differences in the United States, where there have been outright bank failures and where Fed rate moves have been part of the stress causing the turmoil.
Ms. Swonk, of KPMG, said that she did not think the E.C.B.’s actions would serve as a road map for the Fed “given that the road is shifting as we speak,” and that she expected policymakers to hold off on a rate move this week.
“At this point in time, for the Fed, a pregnant pause is warranted,” she said. “It’s a marathon, not a sprint — hold back now, promise to do more later if needed.”
Source: www.nytimes.com
