Fed rates, projections, stability concerns a 'mess' to be sorted
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[March 21, 2023] By
Howard Schneider
WASHINGTON (Reuters) - The U.S. Federal Reserve begins a two-day meeting
on Tuesday, with some top central bank watchers saying it could well
pause further rate hikes given recent trouble among banks or even delay
releasing new economic projections because the outlook is so clouded.
Or not.
The Fed meeting concludes Wednesday with the 2 p.m. EDT (1800 GMT)
release of a new policy statement and a 2:30 p.m. press conference by
Fed Chair Jerome Powell, and if all goes as planned, the release of new
projections for the economy and path of interest rates.
But as much as at any point since the March 2020 onset of the COVID-19
pandemic, the full dimensions of the outcome seem in doubt as officials
try to balance the need to keep pressure on the economy to lower
inflation, strike the right note of caution about financial stability,
and avoid any missteps that could make investors think things are worse
- or better - than they are.
"This is all a bit of a mess," Krishna Guha, vice chair of ISI Evercore
and a former New York Federal Reserve official, wrote ahead of a Federal
Open Market Committee meeting that has veered from a dead-certain jump
in interest rates two weeks ago to a speculative morass.
After high-profile U.S. bank failures beginning March 10 and the
emergency rescue of Europe's Credit Suisse over the weekend, markets
appeared calmer on Monday with some sense that actions taken by the Fed
and other central banks would keep the financial system stable - and not
allow it to degenerate in a series of failures.
Investors in securities tied to the target federal funds rate still put
a roughly 70% probability on policymakers approving a quarter-point rate
increase, which would push the target federal funds rate to a range
between 4.75% and 5%. The yield on the 2-year Treasury note -
particularly sensitive to Fed policy expectations - rose steadily
through the day, adding roughly a quarter of a point from the overnight
low and approaching 4%.
But, for a security tied closely to expectations about Fed policy, that
still marks a dramatic fall from March 9 when the 2-year topped 5% and
markets were digesting a hawkish message from Powell that the policy
interest rate would need to rise higher and perhaps faster than
anticipated.
IT'S TRICKY
The March 10 failure of Silicon Valley Bank threw the outlook into
turmoil, and while the situation has settled down, the sense of flux
seeped deeply into the debate about what the Fed is likely to do with a
suddenly tricky decision over how to keep pressure on the economy to
slow inflation without pushing a swath of midsized banks to the snapping
point.
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An eagle tops the U.S. Federal Reserve building's facade in
Washington, July 31, 2013. REUTERS/Jonathan Ernst/File Photo
Analysts trying to parse what recent bank stress might mean said a
coming credit contraction could be the equivalent of an additional
quarter point Fed rate increase, or as much as a recession-inducing
1.5 percentage points, rendering further rate hikes obsolete.
"Could they? Will they? Should they?" EY-Parthenon Chief Economist
Gregory Daco puzzled in an essay. "Yes, the Fed could continue to
tighten monetary policy...Yes, the Fed will likely raise the federal
funds rate by 25 basis points...No, the Fed shouldn’t...The optimal
approach would be to pause" and take stock of whether bank stress
will or will not cause a problem.
KPMG Chief Economist Diane Swonk went further, saying the Fed should
not only delay any further rate hikes, but also withhold economic
projections scheduled to be released at the conclusion of this
week's meeting because they would "create more chaos than clarity."
"Providing guidance on where individual members of the leadership of
the Federal Reserve system see rate hikes and the economy going now
seems counterproductive," Swonk wrote, given the possibility that
any projection - whether for continued higher rates to fight
inflation or a dovish path in deference to financial stability -
could be misconstrued.
But her recommendation - and she wasn't alone in suggesting the Fed
might delay its quarterly Summary of Economic Projections - also
hinted at the risks involved when a central bank does anything
unexpected.
Since the Fed began publishing its quarterly estimates in 2012, the
only time it has failed to do so was in March 2020 when the onset of
the coronavirus pandemic put the economy on the verge of collapse -
a comparison the Fed would not want people to make with the current
state of affairs.
Bank of America analysts said they thought the Fed would proceed
with a quarter point increase, but shape the message in its
statement and in Powell's press conference to take stock of the last
two weeks.
"The emergence of financial stress is likely to indicate to the
committee that monetary policy is closer to being 'sufficiently
restrictive' than some may have thought previously," BOA economists
wrote. "At the very least, stress in financial markets suggests that
the Fed should proceed with caution."
(Reporting by Howard Schneider; Editing by Dan Burns and Andrea
Ricci)
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