Federal Reserve officials have a difficult path ahead of them. They still have work to do to bring inflation down, but their efforts have been complicated by the events of the past few weeks.
The failures of Silicon Valley Bank and Signature Bank and the ongoing stress in the regional banking sector (there may be nearly 190 lenders at risk of failure, according to a new study) have put the Federal Reserve in a strange situation. Policymakers don't want to raise interest rates and risk further damage to the system, but Fed officials also remain worried about persistent inflation.
Two weeks ago, officials had likely planned to hike rates by at least half a percentage point. Now, the banking meltdown has complicated that strategy.
Wall Street is betting on a quarter-point hike, while some prominent economists are calling for a temporary pause.
But in a strange twist, it's possible that the banking meltdown actually did some work for the Fed in bringing down prices without raising interest rates.
What's happening: Fears of a bank run cause lenders to take fewer risks with their capital reserves to ensure they have enough cash to cover any potential withdrawal requests, said analysts at Pantheon Macroeconomics. That makes them "disinflationary events," they wrote in a note on Tuesday.
Economic growth could be reduced by as much as half a percentage point in 2023 if small and midsize banks tighten their lending standards. That could have the equivalent effect of the Fed hiking rates by half a point, said Goldman Sachs economists on Tuesday.
That's because banks with less than $250 billion in assets account for about 50% of US commercial and industrial lending, 60% of residential real estate lending, 80% of commercial real estate lending and 45% of consumer lending, according to Goldman analysts led by chief economist Jan Hatzius.
Torsten Slok, chief economist at Apollo Global Management, estimated in a note that the banking meltdown could have an even larger effect on the economy, equivalent to a percent-and-a-half rate hike by the Fed.
"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 wrote in a note over the weekend.
The other side: Still, some economists don't think the Fed is off the hook. Mohamed El-Erian, chief economic adviser at Allianz, wrote in The Financial Times this week that if the Fed doesn't increase interest rates, it would "set up more policy flip-flops that fail to deliver a soft landing while amplifying unsettling financial volatility."
In an interview with Bloomberg this week, former US Treasury Secretary Larry Summers said the Fed should be wary of falling prey to financial dominance — when the Fed doesn't tighten monetary policy because of potential risks to the stability of the financial system.
"It would be very unfortunate if, out of solicitude for the banking system, the Fed were to slow down its rate of interest-rate increase beyond what was appropriate given the credit contraction," he said.
Comments
Post a Comment