Financial or price stability? Fed faces calls to pause
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[March 20, 2023] By
Paritosh Bansal and Ira Iosebashvili
(Reuters) -With the U.S. and European banking crisis wreaking havoc in
global markets, some financial industry executives are calling on the
Federal Reserve to pause its monetary policy tightening for now but be
ready to resume raising rates later.
Investors are currently pricing a 60% probability that the Fed will
raise rates by 25 basis points on Wednesday, with the remainder betting
on no change. Some industry executives 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, chief executive of financial advisory at
investment bank Lazard Ltd. Orszag said the Fed should pause but be
ready to hike again gradually as the situation develops.
The central bank declined to comment. Fed officials are in their
pre-meeting blackout period, during which they are barred from
commenting on monetary policy or the economic outlook.
The Fed has rapidly raised interest rates over the past year in a bid to
beat back inflation, at a pace not seen since the 1980s. Others have
joined in, with the European Central Bank raising rates by 50 basis
points earlier this week.
The rapid rise in rates after years of cheap money is rippling through
global markets and industry. Two U.S. banks have failed over the past
week and others have come under pressure, while Swiss lender Credit
Suisse is scrambling to pull together a rescue deal this weekend.
Tumult in the banking sector has roiled asset prices, sending U.S.
government bond yields plummeting in the past week, with some investors
complaining that massive price swings have made it more difficult to
trade. U.S. stocks took a rollercoaster ride, though the S&P 500 managed
to close higher on the week despite steep losses in bank shares.
WILD CARD
Some market observers have argued that a sustained pause could fuel
worries that consumer prices will rebound.
Recent U.S. economic data give the Fed little reason to believe it has
defeated inflation. Consumer prices rose at a 6% annual rate in
February, nearly three times the central bank’s target, and there have
been only nascent signs of a significant easing in hiring and wage
growth.
"While the banking woes will certainly command attention, we believe
that it is not systemic but more of a liquidity issue that the Fed can
contain with its lending facilities," wrote Bob Schwartz, senior
economist at Oxford Economics, in a note.
But he added that the "wild card" will be market reaction.
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Federal Reserve Board Chairman Jerome
Powell appears on a screen on the trading floor of the New York
Stock Exchange (NYSE) during a news conference following a Fed rate
announcement, in New York City, U.S., February 1, 2023.
REUTERS/Andrew Kelly/File Photo
James Tabacchi, chief executive of broker-dealer South Street
Securities, said he thought the Fed would eventually need to go
above 6%. The current Fed funds rate is 4.5% to 4.75%.
"I am an inflation hawk. But what will it hurt to wait a month and
say, 'We’d like to see the market stabilize?'” Tabacchi said. "I
think the Fed should pause."
DISINFLATIONARY TRENDS
Orszag, who served as the director of the U.S. Office of Management
and Budget in the Obama administration, said as long as long-term
inflationary expectations were not unhinged, as was the case now,
the Fed had time. Raising rates too rapidly could break things, as
the current banking crisis demonstrated.
A number of factors pointed to 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 may explain between 30% and
70% of elevated core PCE inflation in the fourth quarter of 2022.
That would work out 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 this past week
correspond to a 1.5% increase in the Fed funds rate, Slok wrote.
“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,” he said.
BlackRock Inc strategists argued that the gyrations of the past week
showed that markets had woken up to 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.
(Reporting by Paritosh Bansal and Ira Iosebashvili; additional
reporting by Dan Burns; Editing by Nick Zieminski)
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