MNI INTERVIEW: Fed Hikes Over, Banks Still Vulnerable-George

Federal Reserve policymakers have probably finished raising interest rates because inflation continues to come down and the effects of past increases are still being felt, particularly in vulnerable parts of the banking system, ex-Kansas City Fed President Esther George told MNI.

“I do expect that they have hit a peak in terms of the interest rate,” George said in the latest episode of MNI’s FedSpeak Podcast. “Pausing is a good idea at this stage because this has been a very aggressive rate hike and I’m among those that think that policy lags are real and that we have not yet seen them go fully through the economy.” (See MNI INTERVIEW: Fed Convinced Past Hikes' Full Effect Still To Hit)

Indeed, George is concerned that some of these lags could be about to create fresh headaches for more vulnerable parts of the financial system, like the regional banks that got into trouble back in March.

BANKING WOES

“I’m not terribly sanguine about credit conditions. I think banks are only one shock away from having some problems or we are beginning to see some of the early signs of credit turning, both a tightening of their own credit policies but also some delinquencies,” said George, who spent more than four decades at the Fed and began her career as a bank examiner.

She thinks the Fed will face strong incentives to renew its Bank Term Funding Program, which alleviated pressures on bank balance sheets by allowing them to use underwater Treasuries at par as collateral for fresh loans, when it expires in March of 2024.

“There will be a lot of pressure to try to provide a support like that. For small banks in particular this has been a pretty important facility for them,” she said. “It will require thinking about, are we through this period, is there no reason to worry about contagion? And that will be coming at a time when I predict credit conditions could be souring a bit.”

POSITIVE CPI SURPRISE

George welcomed better-than-expected CPI figures showing consumer prices held mostly steady in October while the annual rate of inflation fell to 3.3% from 3.7%.

She also cautioned that it’s far too early for Fed officials to declare victory with core inflation still above 4%.

“There’s no question this was a positive number and that is welcome progress. But I think we should be reminded that there is still room to go for the Fed to achieve its objective,” George said. (See MNI: Fed's Barkin Not Yet Convinced Inflation On Path To 2%)

The former KC Fed chief remains skeptical the economy can avoid at least a mild downturn in the process of getting inflation back down to target.

“I’ve not been one to really embrace soft landings. It’s just very difficult to do when you have a blunt instrument like a short-term interest rate and you’ve got a big balance sheet you’re committed to bringing down quickly,” she said.

QT POLICY EXPERIMENT

The Fed’s efforts to reduce its very large balance sheet, which peaked at around USD9 trillion, at a fairly rapid clip, have thus far been successful, yet also raise a number of concerns.

“We don’t have many experiences with this policy instrument. It looks like there are still plentiful reserves in the system. The overnight reverse repo facility is also beginning to come down, so there’s room, it would look like, to continue that,” said George.

“But I’m also mindful that we were a buyer of Treasuries at a time when we are looking around the world to say the Treasury is issuing a lot of debt, the interest expense on that debt is creating an even more unsustainable path for fiscal and the Fed is now backing away.”