Source: Wall Street News

On Monday, March 20, Wall Street Journal reporter Nick Timiraos, regarded as the “mouthpiece of the Federal Reserve” and known as the “New Federal Reserve News Agency,” wrote that under the current circumstances, the Fed is facing difficult decisions on whether to raise interest rates, and Fed officials must balance concerns about inflation and new concerns about the spillover effects of turmoil in the banking industry.

Timiraos put it bluntly:

Federal Reserve Chairman Powell and his colleagues faced one of their toughest decisions in years this week: whether to raise interest rates again to counter stubbornly high inflation, or to suspend interest rate hikes amid the worst banking crisis since 2008.

Timiraos believes that the Federal Reserve's decision on whether to continue raising interest rates by 25 basis points may depend in part on how the market digests the news of UBS's acquisition of Credit Suisse, and whether the measures taken by the US and other economies to calm market concerns about the banking industry are effective. On Wednesday, the Federal Reserve will announce its interest rate decision.

Over the past year, Federal Reserve officials have been trying to convey all kinds of clues about changes in their interest rates before interest rate meetings to avoid market surprises and minimize fluctuations. However, in the past year, the Federal Reserve has never faced such a rapidly changing and impactful crisis.

On Monday, according to CME statistics, investors expect the Federal Reserve to continue to raise interest rates, and the market suggests that the possibility of raising interest rates by 25 basis points is about three-quarters.

Timiraos believes that at this interest rate meeting, Fed officials are likely to disagree: those Federal Reserve officials who think that loans and other financial conditions are at risk of sudden tightening due to current banking risk shocks may be inclined to suspend interest rate hikes; those who think that the impact of the banking crisis is more likely to be temporary, controlled, or moderate may argue for continuing a new rate hike while the inflation rate is still high, with the aim of cooling the economy to contain inflation.

William English, a former senior economist at the Federal Reserve and professor at the Yale School of Management, said:

It's going to be a tough decision, very tricky.

Federal Reserve officials once again slowed the pace of interest rate hikes in early February, lowering the rate hike to 25 basis points, but this round of interest rate hikes is still the fastest rate hike cycle since the 1980s.

Just before the US regional banking crisis broke out, US economic data showed that employment, consumption, and inflation at the beginning of this year were all stronger than expected. Powell was still discussing with Federal Reserve officials the possibility of raising interest rates to 50 basis points again.

This was followed by a run-in with Silicon Valley banks and the rapid collapse of Silicon Valley banks. To prevent the panic from spreading further, US federal regulators guaranteed the uninvested deposits of Silicon Valley Bank and Signature Bank of New York, which subsequently went out of business. The Federal Reserve is also beginning to lend banks on more generous terms for up to one year.

Despite the swift action of US regulators, Timiraos believes that it is unclear whether these measures will quell broader concerns about the health status of other regional banks. For example, First Republic Bank's stock price, also from California, fell more than 80% this month.

The banking turmoil will have the same effect as the Fed's interest rate hike. Timiraos explained that turmoil in the banking sector could lead to fewer loans as lenders will face more stringent scrutiny from bank regulators and banks themselves to reduce risk taking. Goldman Sachs economists estimate that tightening loan standards due to industry pressure is equivalent to raising the Federal Reserve's benchmark interest rate by 25 basis points or 50 basis points.

Timiraos said that over the past year, Fed officials sometimes acknowledged the risk of being forced to deal with two issues simultaneously — inflation and financial instability. Some Fed officials said they will use emergency loan tools to stabilize the shaky financial sector so they can continue to use higher interest rates to cool inflation.

Richard Clarida, who served as Vice Chairman of the Federal Reserve from 2018 to 2022, said:

I suggest they continue to raise interest rates by 25 basis points. If the Federal Reserve suspends interest rate hikes, the market may discuss whether they know some truth that we don't know.

Others are also concerned that suspending interest rate hikes poses the risk of so-called financial dominance, where monetary policy is too focused on avoiding market pressure to the detriment of fighting inflation.

Duke University economist and former senior adviser to the Federal Reserve, Ellen Meade said:

Powell fought hard to earn the credibility of an inflation fighter. So I think it would be a mistake not to raise interest rates this time around, especially after seeing such strong economic data.

Other former senior Federal Reserve officials are opposed to continuing to raise interest rates this week.

Former Boston Federal Reserve Chairman Eric Rosengren believes:

I'm not going to raise interest rates while the financial environment is tightened due to financial shocks; this is simply adding fuel to the fire. Raising interest rates by 25 basis points now would have a fairly moderate impact on inflation, but it could have an amplified impact on financial conditions.

Surveys that track consumer and business expectations of future inflation have remained stable or declining in recent months, and many economists believe that future inflation is an important driver of actual inflation. That might support the argument for this week's suspension.

Editor/jayden