By Kelvin Lee, Alonso Munoz
In roughly 20 minutes, we expect the Federal Reserve to raise rates by 25 basis points, bringing the target range to 4.75% – 5%. The decision for the fed to either raise rates or pause will be significantly challenging as bank stability and high inflation are now troubling considerations for the central bank. Either way, it’s a lose-lose scenario for Jerome Powell.
Why 25BPS? By Kelvin Lee
Inflation is still persistently high, and the fed’s preferred inflation gauges (core PCE and CPI) still favor rate increases. However, this decision differs from prior ones as Powell must weigh adding to bank asset losses. The phrase “raise rates ‘til something breaks” was painfully realized with SVB’s collapse, and while there were concentrated risks with SVB, the news cycle of financial instability has already stained the reserve’s reputation. We estimate that Powell will focus on separation of monetary policy measures with financial banking support tools in his post decision speech to justify a rate increase. A rate increase also avoids how a pause could be interpreted: The Fed has so little confidence in bank resiliency and financial markets that they would change course.
Why Pause? By Alonso Munoz
The risk of raising rates is too high. It is highly probable that we have already seen “peak” rates in this economic cycle, and the expectations for rate cuts are rising as the economy deteriorates. The recent bank failures caused historic moves in the yield curve, alongside a sudden increase in the Fed’s balance sheet. This is problematic for the Fed. With inflation still high, why should the fed pause? Financial stability should be absolute priority in making this rate decision. The American people and market participants are quick to react to headline news and panic, causing significant stress on the “pipes” of the global financial system. If the Fed is not prudent, they could pave the road to further deterioration in economic activity and financial conditions. Fighting inflation should not be a zero-sum game, and the Fed should not jeopardize an already fragile economy for their inflation crusade.
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