Analysis: Financial or Price Stability? Fed Faces Calls to Pause

The global banking crisis has left some financial industry executives calling on the Federal Reserve to pause its monetary policy tightening for now but be ready to resume raising rates later. The Fed has rapidly raised interest rates over the past year to beat back inflation. However, some believe that the central bank should prioritize financial stability now.

Financial Stability Before Price Stability?

The chief executive of financial advisory at investment bank Lazard Ltd, Peter Orszag, said the Fed should pause but be ready to hike again gradually as the situation develops. He suggested the central bank prioritize financial stability over price stability.

Orszag argued that as long as long-term inflationary expectations were not unhinged, as was the case now, the Fed had time. As the current banking crisis demonstrated, raising rates too rapidly could break things. Orszag, who served as the director of the U.S. Office of Management and Budget in the Obama administration, said several factors pointed to lingering effects of the pandemic on inflation, such as supply-chain disruptions and demand for travel and entertainment.

James Tabacchi, chief executive of broker-dealer South Street Securities, echoed Orszag and said he thought the Fed would eventually need to go above 6%. Still, the central bank should pause and wait for the market to stabilize.

The Wild Card Will Be Market Reaction

While some market observers have argued that a sustained pause could fuel worries that consumer prices will rebound, others said the “wild card” will be the market reaction. For example, Bob Schwartz, the senior economist at Oxford Economics, noted that while the banking woes will certainly command attention, he believed it “is not systemic but more of a liquidity issue that the Fed can contain with its lending facilities.”

Recent U.S. economic data give the Fed little reason to believe it has defeated inflation. Consumer prices rose at a 6% annual rate in February, nearly three times the central bank’s target, and there have been only nascent signs of a significant easing in hiring and wage growth.

Related Facts:

• Investors are currently pricing a 60% probability that the Fed will raise rates by 25 basis points on Wednesday.
• The European Central Bank recently raised rates by 50 basis points.
• Two U.S. banks have failed over the past week, while Swiss lender Credit Suisse is scrambling to pull together a rescue deal this weekend.
• The rapid rate rise after years of cheap money ripples through global markets and industries.

Key Takeaway:

As the Fed remains in its pre-meeting blackout period, it is unclear if they will heed the calls to pause on monetary policy tightening. Moreover, as the global banking crisis continues to wreak havoc on markets, financial industry executives are urging the central bank to prioritize financial stability over price stability. With inflation concerns still at the forefront, it will be interesting to see how the Fed balances these competing interests.

Conclusion:

The Fed is facing mounting pressure to pause its rapid rise in interest rates and prioritize financial stability over price stability. While some argue that a sustained pause could fuel inflation worries, others point to the market reaction as the potential “wild card.” Ultimately, how the central bank will respond to these calls remains to be seen. Still, one thing is clear: the global banking crisis continues to roil markets and industry, adding another layer of complexity to the Fed’s decision-making process.