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One year after first rate hike, Fed stands at policy crossroads

BusinessEconomyOne year after first rate hike, Fed stands at policy crossroads
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US Federal Reserve Chairman Jerome Powell answers a question from David Rubenstein (not pictured) during a discussion on the dais at a meeting of The Economic Club of Washington in Washington, DC, US, February 7, 2023. Reuters / Amanda Andrade-Rhodes

Amanda Andrade-Rhodes | reuters

The Federal Reserve is a year down its rate-hiking path, and in some ways it is both closer and further from its targets than when it first set sail.

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Exactly one year ago on 16 March 2022 the The Federal Open Market Committee first enacted 8 What will be the increase in the interest rate. The goal: to stem a stubborn inflation wave that central bank officials spent the better part of a year dismissing as “fleeting.”

Inflation since the year as measured by the consumer price index Some have come down, from 8.5% annualized rate to 6% now and going lower. While this is progress, it still leaves the Fed well short of its 2% target.

And it raises questions about what lies ahead and what its impact will be as policy makers grapple with the persistently high cost of living and a shocking banking crisis.

“The Fed will admit they were late to the game, that inflation has been more stable than they expected. So they probably should have tightened sooner,” said Gus Faucher, chief economist at PNC Financial Services Group. “That being said, given the fact that the Fed has tightened aggressively, the economy is still doing very well.”

There is an argument for that point about evolution. While 2022 was a weak year for the US economy, 2023 is at least starting on solid ground a strong labor market, But recent days have shown that the Fed has a problem other than inflation.

All monetary policy tightening – a 4.5 percentage point rate hike, and a $573 billion balance sheet roll-off of quantitative tightening – is tied to significant dislocations that are now ripple through the banking industryEspecially hitting small institutions.

Unless this pandemic is brought under control soon, the banking issue may overshadow the inflation battle.

‘Collateral damage’ from rate hike

“The chapters are only now beginning to be written” regarding the impact from last year’s policy moves, said Peter Bockover, chief investment officer at Bleakley Advisory Group. “Not only does a lot of collateral damage happen when you raise rates after a long period at zero, but the speed at which you do so creates a boom in the China shop.”

“The bull was able to skate until recently without knocking anything over,” he said. “But now it’s starting to knock things over.”

Rising rates have forced banks to hold otherwise safe products such as Treasuries, mortgage-backed securities and municipal bonds.

Because prices fall when rates rise, Fed hikes cut into the market value of those fixed income holdings. In the case of Silicon Valley Bank, it was forced to sell billions of holdings at huge losses, which contributed to crisis of faith Which has now spread elsewhere.

That leaves the Fed and the chairman Jerome Powell With a key decision to be made in six days, when the rate-setting FOMC releases its post-meeting statement. Does the Fed follow through with its oft-stated intention to keep raising rates until it tames inflation toward acceptable levels, or does it step back to assess the current financial situation before moving forward ?

rate hike expected

“If you’re waiting for inflation to go back to 2% and that’s why you raised rates, you’re making a mistake,” said Joseph Lavorgna, chief economist at SMBC Nikko Securities. “If you are on the Fed, you want to buy arbitrariness. The easiest way to buy arbitrariness is to hold next week, stop Qt and just wait and see how things go.”

market pricing whipped hard What to expect from the Fed in recent days.

As of Thursday afternoon, traders expected a rate hike of 0.25 percentage points, pricing in an 80.5% chance of a move that would move the federal funds rate to a range of 4.75%-5%, according to cme group data,

With the turmoil in the banking industry, LaVorgna thinks that would be a bad idea at a time when confidence is waning.

Depositors have pulled $464 billion out of banks since the rate hikes began, according to Fed data. That’s a 2.6% drop after a massive jump in the early days of the Covid pandemic, but the strength of community banks could come into question.

Watch CNBC's full interview with Jim Grant of Grant's Interest Rate Observer

“He corrected one policy mistake with another,” said Lavorgna, chief economist at the National Economic Council under former President Donald Trump. “I don’t know if it was political, but they went from one extreme to the other, neither of which is good. I wish the Fed had a more honest assessment of what they did wrong. But you usually Don’t understand.” from government.”

Indeed, when analysts and historians look back at the recent history of monetary policy, there is a lot to chew on.

Warning signs on inflation began to emerge in the spring of 2021, but the Fed stuck to the belief that increases were “fleeting” until it was forced to act. Since July 2022, the yield curve has also been sending signals, warning of a growth slowdown as short-term yields exceed long-term yields, a situation that has also created serious problems for banks.

Still, if regulators can resolve current liquidity problems and avoid a deep recession in the economy this year, the Fed’s missteps will do minimal damage.

PNC’s Faucher said, “With the experience of the past year, there have been valid criticisms of Powell and the Fed.” “Overall, they have responded appropriately, and the economy is in a good place considering where we are at this point in 2020.”

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