New Fed News Agency: Fed faces tough decision on rate hikes

On Monday, March 20, Nick Timiraos, a reporter for the Wall Street Journal who is regarded as the "mouthpiece of the Federal Reserve " and known as the "New Federal Reserve News Agency," wrote that under the current circumstances, the Federal Reserve faces a difficult decision on whether to raise interest rates. Federal Reserve officials must strike a balance between inflation concerns and new concerns about the spillover effects of banking turmoil.

Timiraos said bluntly: Federal Reserve Chairman Powell and his colleagues face one of their most difficult decisions in years this week: whether to raise interest rates again to fight stubbornly high inflation, or to pause rate hikes amid the worst banking crisis since 2008.

Timiraos believes that the Fed'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 United States and other economies to calm market concerns about the banking industry are effective. The Federal Reserve will announce its interest rate decision on Wednesday.

In the past year, Fed officials have tried to convey various clues about their interest rate changes before the meeting to avoid market surprises and minimize volatility. However, in the past year, the Fed has never faced such a fast-changing and huge crisis.

On Monday, according to CME Group, investors expect the Federal Reserve to continue raising interest rates, with the market implying about a three-quarter chance of a 25 basis point increase.

Timiraos believes that there is a high probability of disagreement among Fed officials at this interest rate meeting: those who believe that loans and other financial conditions are at risk of a sudden tightening due to the current banking risk shock may tend to suspend interest rate hikes; those who believe that the impact of the banking crisis is more likely to be temporary, controlled or mild may advocate continuing with a new round of interest rate hikes while inflation remains high, aimed at cooling the economy to curb inflation.

“This is going to be a difficult decision, very tricky,” said William English, a former senior Federal Reserve economist and professor at the Yale School of Management.

Fed officials slowed the pace of rate hikes again in early February, reducing the pace of increases to 25 basis points, but this round of rate hikes is still the fastest rate hike cycle since the 1980s.

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

A run on Silicon Valley Bank followed, and its rapid collapse. To prevent further spread of panic, federal regulators guaranteed uninsured deposits at Silicon Valley Bank and the then-collapsed Signature Bank of New York. The Federal Reserve also began lending to banks on more generous terms for periods of up to a year.

While U.S. regulators acted quickly, Timiraos said it was unclear whether the measures had calmed broader concerns about the health of other regional banks, including First Republic Bank, also from California, which has seen its stock price fall more than 80% this month.

Banking turmoil could also have a similar effect to the Fed's rate hikes. Timiraos explained that banking turmoil could lead to a reduction in lending as lenders face greater scrutiny from bank regulators and banks themselves to reduce risk-taking. Goldman Sachs economists estimate that tightening lending standards due to industry pressures is equivalent to a 25 basis point or 50 basis point increase in the Fed's benchmark interest rate.

Timiraos said that over the past year, Fed officials have at times acknowledged the risk of being forced to deal with two problems at once — inflation and financial instability. Some Fed officials have said they would use emergency lending tools to stabilize a 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 that they continue with the 25 basis point rate hike. If the Fed pauses, the market may discuss whether they know some truth that we don't know."

Others also worry that a pause in rate hikes carries the risk of so-called financial dominance, in which monetary policy becomes too focused on avoiding market stress to the detriment of fighting inflation.

Ellen Meade, an economist at Duke University and a former senior adviser to the Federal Reserve, said: "Powell has fought hard to gain credibility as an inflation fighter. Therefore, I think it would be a mistake not to raise rates this time, especially after seeing such strong economic data."

Other former senior Fed officials opposed further rate hikes this week.

Eric Rosengren, former president of the Federal Reserve Bank of Boston, believes: "I will not raise interest rates at the same time as the financial shock leads to a tightening of the financial environment. This is simply adding fuel to the fire. A 25 basis point rate hike now will have a fairly mild impact on inflation, but it may have an amplified impact on financial conditions."

Surveys tracking consumers’ and businesses’ expectations for future inflation, which many economists consider an important driver of actual inflation, have remained stable or declined in recent months. That could support the argument for a pause this week.