March 18 (Reuters) – As the US and European banking crises wreak havoc on global markets, some financial industry executives are urging the Federal Reserve to pause its monetary tightening for now but be ready to hike rates again later.
Investors are currently rating a 60% chance that the Fed will hike rates by 25 basis points on Wednesday, while the rest are betting on no change. Some industry executives said the central bank should now prioritize financial stability.
“Come on financial stability fast and hard; Move gradually and slowly towards price stability,” said Peter Orszag, Chief Executive of Financial Advisory at investment bank Lazard Ltd (LAZ.N). Orszag said the Fed should pause but be ready to gradually hike again as the situation develops.
The central bank declined to comment. Fed officials are in their pre-meeting blackout period, during which they are prohibited from commenting on monetary policy or the economic outlook.
The Fed has been raising interest rates rapidly over the past year at a rate not seen since the 1980s in a bid to curb inflation. Others have joined, with the European Central Bank raising interest rates by 50 basis points earlier this week.
The rapid rise in interest rates after years of easy money is sweeping through global markets and industry. Two US banks failed last week and others have come under pressure while Swiss lender Credit Suisse seeks a bailout deal this weekend.
Turmoil in the banking sector has roiled asset prices and sent US Treasury yields tumbling over the past week, with some investors complaining that wild price swings have hampered trading. US stocks enjoyed a rollercoaster ride, although the S&P 500 managed to end the week higher despite sharp losses in bank stocks.
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WILD CARD
Some market observers have argued that a prolonged pause could stoke fears that consumer prices will recover.
Recent US economic data gives the Fed little reason to believe it has beaten inflation. Consumer prices rose at an annual rate of 6% in February, almost triple the central bank’s target, and there were only early signs of a significant slowdown in hiring and wage growth.
“While the banking problems will certainly attract attention, we believe it is not a systemic problem but rather a liquidity problem that the Fed can use its lending facilities to contain,” wrote Bob Schwartz, senior economist at Oxford Economics, in a note .
But he added that the “wild card” will be market reaction.
James Tabacchi, chief executive of broker-dealer South Street Securities, said he believes the Fed needs to go above 6% at some point. The current fed funds rate is 4.5% to 4.75%.
“I’m an inflation hawk. But what’s the harm in waiting a month and saying, ‘We want the market to stabilize?’” Tabacchi said. “I think the Fed should take a break.”
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DISINFLATIONARY TRENDS
Orszag, who served as director of the US Office of Management and Budget in the Obama administration, said as long as long-term inflation expectations haven’t gotten out of hand, as they are now, the Fed has time. Raising rates too quickly could ruin things, as the current banking crisis has shown.
A number of factors pointed to the ongoing impact of the pandemic on inflation, including supply chain disruptions and demand for travel and entertainment.
In a new paper, Orszag and co-author Robin Brooks, chief economist at the Institute of International Finance, estimated that lagging effects related to delivery times could explain between 30% and 70% of elevated core PCE inflation in the fourth quarter of 2022. That would work over time and be a disinflationary force this year, they said.
Torsten Slok, chief economist at Apollo Global Management, wrote in a note on Saturday that the recent turmoil in the banking sector is already tightening financial conditions. The events of the past week correspond to a 1.5% hike in Fed interest rates, Slok wrote.
“In other words, monetary conditions have tightened over the past week to the extent that risks of a deeper slowdown in the economy have increased,” he said.
BlackRock Inc (BLK.N) strategists argued that last week’s swings showed that markets had recognized the damage caused by the rapid rise and were pricing in a recession.
“The trade-off for central banks – between fighting inflation and protecting both economic activity and financial stability – is now clear and immediate,” they wrote in a report earlier this week.
Reporting by Paritosh Bansal and Ira Iosebashvili; additional reporting by Dan Burns; Edited by Nick Zieminski
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