MNI INTERVIEW: Banks Need Not Deter Fed Inflation Fight-Lacker

The Federal Reserve should keep raising interest rates to ensure that borrowing costs adjusted for inflation become convincingly positive, despite banking troubles that have raised speculation about a pause in rate hikes, ex-Richmond Fed President Jeffrey Lacker told MNI Wednesday.

However, a history of caving to market pressures for bailouts and rate-related interventions means Fed officials have to redouble their message about the primacy of the inflation fight, Lacker said in an interview.

“It shouldn’t affect the monetary policy equation very much at all, but it’s likely that the Fed has conditioned people to expect an effect and that’s unfortunate,” Lacker said. “Because markets think the Fed is going to give them a 'Greenspan put' as it were, now they’ve got a bigger hole to dig out. They’ve got to walk markets back up again. They’ve got to redo all the work they did to convince the markets they mean business.”

Lacker said the February CPI report out this week, which showed a 0.5% monthly jump in prices excluding food and energy, was a worrisome sign that price pressures remain broad and persistent.

“I took that as a bad report. Core firmed up and there’s stuff in the pipeline like used cars that are going to show up – the pressures still there. This core non-shelter is still accelerating, so I didn’t think it was a good report at all,” he said. (See MNI INTERVIEW: Inflation More Persistent-Fed's Garriga)

FED TOO SANGUINE

“That’s why bonds might be rallying so much – the market knows the Fed realizes that its rate increases were the thing that sank SVB, and this huge overhang of unrealized, held-to-market losses out there. Maybe the Fed is just worried about more problems in the banking system.”

Lacker said Fed communications suggesting the fight against inflation would come with minimal costs was unhelpful at best.

"They make it sounds like policy is goldilocks, just tight enough but not too tight. But there’s all this historical evidence about what they’re going to have to do," he said. "The economists who are paying attention to those precedents are saying this is going to take raising the real rate 1% or 2%. They haven’t even made it zero yet. This is kind of a mess for the Fed."

RUMBLING INFLATION

Still, that would be a poor reason to back off monetary tightening when inflation is still far above the 2% target, Lacker said. “You don’t want them to hold off rate increases just to limit the downside of bank capital losses. That would be a terrible idea.”

“If that’s the case, then we’re going to get into that scenario that Jay Powell said he didn’t want, where inflation just rumbles along at 4%-5% for a couple of years," he said.

Fed rate hike expectations have swung wildly in line with bond yields in the past week. Markets went from pricing in a 50 basis point rate hike next week and a peak funds rate of 5.5% or higher to betting on a pause, and now settling on a quarter-point hike. The situation remains very fluid as the crisis at Credit Suisse compounds U.S. banking concerns.

Lacker, a long-time critic of bank bailouts and excessively large safety nets for the financial system, said the fact that a bank of SVB’s size received a systemic exemption reveals just how little the term means.

“It’s really murky. It’s whatever causes central banks to intervene,” he said. “Systemic is the magic word in the statute that means you can bail out anyone. There’s no theoretical consensus model that this is systemic, and this isn’t.”