ANALYSIS – Financial stability or price stability? The Fed faces calls for a break
By Paritosh Bansal and Ira Iosebashvili
March 18 (Reuters) – As the U.S. and European banking crisis wreaks havoc on global markets, some financial industry leaders are calling on the Federal Reserve to hold off on monetary policy tightening for now, but be ready to resume raising rates more late.
Investors are currently pricing in a 60% chance of the Fed raising rates by 25 basis points on Wednesday, with others betting on no change. Some industry executives have said the central bank should prioritize financial stability now.
“Go fast and hard on financial stability; go gradual and slow on price stability,” said Peter Orszag, managing director of financial advisory at investment bank Lazard Ltd. LAZ.N. Orszag said the Fed should pause but be prepared to gradually increase again as the situation evolves.
The central bank declined to comment. Fed officials are in their pre-meeting blackout period, during which they are not allowed to comment on monetary policy or the economic outlook.
The Fed has rapidly raised interest rates over the past year in an effort to bring down inflation, at a pace not seen since the 1980s. Others joined in, the European Central Bank having raised rates by 50 basis points earlier this week.
Rapidly rising rates after years of cheap money are rippling through global markets and industry. Two US banks went bankrupt last week and others came under pressure, while Swiss lender Credit Suisse is interference to strike a bailout deal this weekend.
The tumult in the banking sector rattled asset prices, sending US government bond yields free fall last week, with some investors complaining that massive price swings have made it more difficult to exchange. US stocks have been on a rollercoaster ride, although the S&P 500 managed to close higher this week despite steep losses in bank stocks.
Some market watchers argued that a prolonged pause could stoke fears of a rebound in consumer prices.
Recent US economic data gives the Fed little reason to believe it has beaten inflation. Consumer prices rose at an annual rate of 6% in February, almost three times the central bank’s target, and there were only incipient signs of a significant slowdown in the growth of hiring and salaries.
“While banking issues will certainly get attention, we believe this is not a systemic issue but rather a liquidity issue that the Fed can contain with its lending facilities,” Bob wrote. Schwartz, senior economist at Oxford Economics, in a note.
But he added that the “joker” will be the market reaction.
James Tabacchi, managing director of broker-dealer South Street Securities, said he believes the Fed will eventually have to rise above 6%. The current federal funds rate is 4.5% to 4.75%.
“I’m an inflation hawk. But what’s it going to be like to wait a month and say, ‘We’d like to see the market stabilize? ‘” Tabacchi said. “I think the Fed should take a break.”
Orszag, who served as director of the U.S. Office of Management and Budget in the Obama administration, said that as long as long-term inflation expectations were not out of balance, as they were now, the Fed had the time. Raising rates too quickly could ruin things, as the current banking crisis has demonstrated.
A number of factors highlighted the lingering effects of the pandemic on inflation, such as supply chain disruptions and demand for travel and entertainment.
In a new paper, Orszag and co-author Robin Brooks, chief economist at the Institute of International Finance, estimated that lagged effects associated with delivery times can explain between 30% and 70% of core inflation. High PCE in Q4 2022. This would work over time and be a disinflationary force this year, they said.
Torsten Slok, chief economist at Apollo Global Management, wrote in a note on Saturday that the recent tumult in the banking sector is already tightening financial conditions. The events of the past week correspond to a 1.5% increase in the federal funds rate, Slok wrote.
“In other words, over the past week monetary conditions have tightened to such a degree that the risks of a deeper downturn in the economy have increased,” he said.
BlackRock Inc. BLK.N the strategists argued that the swings over the past week showed that the markets had realized the damage caused by the rapid rise and were pricing in a recession.
“The trade-off for central banks – between fighting inflation and protecting both economic activity and financial stability – is now clear and immediate,” they wrote in a report earlier this week.
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(Reporting by Paritosh Bansal and Ira Iosebashvili; Additional reporting by Dan Burns; Editing by Nick Zieminski)
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