Walking while chewing gum? Fed must simultaneously combat inflation while calming bank worries.
Faced with ongoing instability in the banking system and persistent consumer price increases, the Federal Reserve has an unusually tricky choice to make between a familiar set of options: raise interest rates or don’t.
If Fed officials choose the former at the end of their regularly scheduled two-day policy meeting kicking off Tuesday, they’ll be prioritizing the inflation challenge, even if it means risking further turmoil on Wall Street over a series of meltdowns and takeovers for troubled lenders.
If policymakers opt instead to leave rates alone — virtually no one expects a rate cut — it will represent a pause on the crusade against inflation and a sign that tamping down banking jitters is the more pressing need.
Regardless of the outcome, all eyes will be on Fed Chair Jerome Powell, who is set to deliver remarks at 2:30 p.m. ET Wednesday, for indications of how the Fed sees its role in navigating the storm.
The central bank is also scheduled to release its quarterly round of economic projections Wednesday, which will include policymakers’ forecasts on inflation and rate hikes through 2025.
The latest 12-month inflation data came in at 6% for February. That was slightly lower than January’s 6.4% level — and down from a 9% peak last summer — but still well above the Fed’s 2% target, showing that price pain for consumers is lingering despite gradual declines.
A more detailed inflation measure the Fed has been watching, so-called supercore inflation — which measures price increases driven by everyday services costs like haircuts or meals out — even increased slightly last month, leading many analysts to anticipate further rate hikes were likely.
The recent collapses of Silicon Valley Bank and Signature Bank, followed by a rush to shore up the finances of Credit Suisse and First Republic, scrambled those forecasts. Current expectations are mixed: Many analysts expect a quarter-percentage-point interest rate hike Wednesday, while others anticipate a pause.
That is partly because the Fed’s own actions to curb inflation have been seen as factors in the bank collapses. The problems that sparked the meltdowns were distinct to each of the two failed lenders, but higher interest rates had put pressure on both — as they have across the financial industry.
By raising its key federal funds interest rate, the Fed sets off a chain reaction of rate increases in other parts of the economy, making it more expensive to borrow and invest and thus cooling demand for goods and services.
That is precisely the central bank’s desired outcome in its fight against inflation. The Fed has hiked its effective rate from near zero a year ago to more than 4.5% today. After its eight consecutive increases, consumers now face higher borrowing costs in a range of places, from credit card interest rates of nearly 20% to auto loan rates of about 6.5%.
“They’re saying, ‘We have to weigh that inflation fight versus the banking system and adding more stress in an already stressed system,’” said Michael Antonelli, managing director at Robert W. Baird & Co. financial services group, referring to Fed officials. “It’s just not easy for them right now.”
In a note to clients Monday, economists at Goldman Sachs said that while policymakers at the Fed and in Europe have responded aggressively to shore up the global financial system, “markets appear to be less than fully convinced that efforts to support small and midsize banks will prove sufficient.”
As a result, they wrote, they “think Fed officials will therefore share our view that stress in the banking system remains the most immediate concern for now” and will hold off on another increase.
Neil Dutta, head of economics at Renaissance Macro Research, took a different view, writing in a note Monday that the “Fed can show it knows how to walk and chew gum.”
While the central bank does not usually increase rates during periods of financial instability, Dutta said, “the Fed has different tools to deal with different problems.” He noted that regulators around the world, including the Fed, have taken steps in recent days to give banks wider access to funding to forestall a broader crisis.
Dutta said in his note that he expected a 0.25% rate hike, adding, “I think it is premature to assume the inflation outlook has changed much because of what we’re seeing unfold in markets.”