Until the March 10 failure of Silicon Valley Bank the higher- and stickier-than-expected path of inflation had warranted steady Fed rate hikes, a singular focus that shaped the policy views of Powell and his colleagues for much of 2022 and several months into 2023. But uncertainty about the health of the banking industry has now touched off a scramble by U.S. regulators, lawmakers and politicians to figure out if a broader financial crisis is developing and how to tighten supervision and regulation in response. "For the time being they are still gauging the impact of what is going on," said Subadra Rajappa, head of U.S. rates strategy at Societe Generale. The economy "will feel the pain of tighter landing standards and tighter regulation ... I don't think it is going to be immediate."
COMING SLOWDOWN "Inflation pressures continue to run high," Powell said on Wednesday, repeating what has been the central bank's tagline since the anti-inflation campaign started more than a year ago. "We remain highly committed to bringing inflation back down," he said, repeating a promise that since March of 2022 has meant steadily higher projected Fed interest rates as inflation escalated. This week, however, was the first time since early 2021 that officials raised their outlook for year-end 2023 inflation - to 3.3% from the 3.1% projected in December - without offsetting it with higher projected interest rates. The projection for the year-end 2023 benchmark overnight interest rate remained at 5.1%. The difference is a possible credit crackdown by banks, and "means that monetary policy may have less work to do," Powell said.
"You can think of it as the equivalent of a rate hike ... Perhaps more than that," Powell noted, citing extensive research that made him regard the impact as "potentially quite real."
A decline in the growth rate of U.S. bank lending is a hallmark of recession. If it gets really bad, as it did around the 2007-2009 recession, credit actually contracts and the downturn is all the worse. Fed officials are watching to see if the U.S. economy hits that middle ground, with the flow of credit slowing and perhaps helping encourage "disinflation," without crashing altogether. Goldman Sachs on Thursday said the research referred to by Powell pointed to a potential hit to 2023 U.S. gross domestic product growth of three-tenths of a percentage point to half a percentage point as banks slow lending, for example, to rebuild capital buffers pummeled by the drop in the value of some of their assets. That would be enough to wipe out the median GDP growth projected by Fed officials for this year of 0.4%.
In fact, aspects of the Fed's latest economic projections point not so subtly to recession.
First-quarter economic growth is likely to be strong, with an Atlanta Fed "nowcast" estimating a 3.2% annual growth rate. To get to 0.4% for the year as a whole implies a "sudden stop of activity," argued Tim Duy, chief U.S. economist at SGH Macro Advisors. Fed officials also see the unemployment rate rising nine-tenths of a percentage point in the remainder of this year. Since the 1950s that much of a rise in unemployment over that short a time has meant a recession.
'CLEAR RECOGNITION'
For now, Powell said he thought the banking sector's
problems would be contained to California-based SVB and the
smaller New York-based Signature Bank , whose failures
were deemed a "systemic risk" by U.S. officials and prompted the
Fed to rapidly create a new lending facility for banks facing
unusual withdrawal demands.
Those facilities as well as other programs at the central
bank are meant to address financial stability concerns so
monetary policy can address inflation, which is still running at
more than double the Fed's 2% target.
Data on the first full week of borrowing from that facility
will be released on Thursday, followed by data on Friday showing
the systemwide changes in bank deposits.
In his news conference on Wednesday, Powell said deposit
flows from banks appeared to have "stabilized over the last
week," even as U.S. money market funds attracted their biggest
weekly inflows in nearly three years.
But financial conditions are tightening. A Chicago Fed index
encompassing interest rates, credit spreads, and other data has
turned higher since the bank failures, and Powell said those
sorts of measures may underestimate what's happening because
they don't fully account for changes in lending conditions.
After raising rates at a record pace over the past year
"there is a clear recognition that it may be time to pause,"
said Rick Rieder, chief investment officer of global fixed
income at BlackRock. "The challenges facing the (Federal Open
Market Committee) today ... take on a particular aura of
complexity."
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Interactive graphic-Unemployment and recession Graphic-Rising unemployment and recession Interactive graphic-Rates and inflation Graphic-Rates to catch up with inflation? Interactive graphic-Powell's policy sprint Graphic-Powell's policy sprint Interactive graphic-Financial conditions are tightening Graphic-Financial conditions are tightening Interactive graphic-Overall bank credit Graphic-Overall bank credit ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^>
(Reporting by Howard Schneider; Editing by Dan Burns and Paul
Simao)
