MNI INTERVIEW: Fed Set For Hawkish Pause On Turmoil-English

The Federal Reserve is most likely to take a break in its interest rate increases at its March meeting because of the turmoil in global financial markets that has resulted from troubles at U.S. regional banks and worries about Credit Suisse, William English, a former director of the Fed's division of monetary affairs, told MNI.

"Things are moving very quickly and we could all feel better by the middle of next week," he said. "But particularly with the spill over to Europe yesterday and the problems with Credit Suisse, it seems like we're going to be in an uncertain period for a while and given that I would have thought the Committee would likely choose to take no action and emphasize it's going to wait and see."

The ECB's 50 basis point rate hike does give the Fed some room to raise rates by 25 basis points next week if it wants but even if policymakers opt to do so, they will reveal a cautious, wait-and-see posture to future rate increases.

It gives them "a little bit of scope to tighten without feeling like they're doing something that would have bigger effects than they like," he said, still leaning in the direction of a pause next Wednesday to assess the situation and gather more information.

LOWER TERMINAL?

The current fed funds rate target at 4.50%-4.75% is likely to have to continue to move up, he said, but maybe not as high as previously thought before the collapse of Silicon Valley Bank and Signature Bank, when rates were largely seen rising to between 5.5% to 5.75% with risks they'd move above 6%. The bond market is pricing in an over 80% chance of a 25 basis point hike next week.

"Some banks are going to be much less interested in intermediating and making loans and so that's going to be a tightening of financial conditions for bank dependent borrowers including a lot of small and medium sized businesses and households. If that effect is big, and if you're the Fed, you just have less tightening to do."

"But the Fed doesn't have a good way to judge how big these effects are going to be by next Wednesday," he said. "They are going to have to make their best call."

"They're going to wait and see how things shake out for a bit longer, but they're still expecting it'll probably be necessary to raise rates further to get inflation down towards their 2% target," said English, a former secretary to the FOMC.

(See: MNI INTERVIEW: Fed Should Pause, Assess Two-Way Risk-Rosengren)

Threading the needle will be tough, he said. "They're going to have to be clear that whatever they do, they're going to be watching the data very carefully and watching the banking system very carefully. And they may have to adjust one way or the other" and that could include earlier rate cuts.

FED'S BTFP

English suggested the government response over the weekend has helped stem the crisis and gives time to banks to make adjustments to manage their situations.

He said a forceful Fed program like the Bank Term Funding Program that lends at par could turn out to be something like the corporate and municipal bond buying programs during the pandemic that had powerful announcement and confidence effects but were later little used.

"I suspect this would be the same," English said, laying out an exception for the two bridge banks that failed and are likely to tap the Fed program. But if there is hundreds of billions in take-up at the facility, then that suggests there should still be some real concern about some of these banks, he said.