MNI INTERVIEW: Fed Seen Pausing In June, Could Restart-Acharya

The Federal Reserve is nearing a pause in its interest rate increases at the June meeting, but compared to past tightening cycles there remains a heightened chance the central bank will have to hike again, possibly later in the year, former Reserve Bank of India deputy governor Viral Acharya told MNI.

"Depending on how the next two or three quarters pan out, there might have to be potential for a hike," he said. "We are heading in the right direction of the inflation trajectory but it doesn't mean that you can give up on the inflation target."

While the central bank may refrain from an eleventh straight hike in June, the Fed will keep a hawkish bias, said Acharya this week at an Atlanta Fed conference, suggesting that bias could be signaled in the Summary of Economic Projections. There are some, he said, "who think the Fed lost a little bit of credibility through this inflation cycle and I think they've got to restore it because you can't allow an unanchoring of long-term market expectations." (See MNI INTERVIEW: Fed's Barkin 'Very Open' To More Tightening)

BANKS IMPACT OUTLOOK

"We can't rule out one or two, maybe even more rate hikes," he said, also noting downside risks emanating from financial fragility that could put rate cuts on the table.

"It doesn't look to me terribly good both in terms of macro and the financial situation for these regional and mid-sized banks."

"To me, that's the main risk that so far they've had interest rate risk, but I think credit risk is lurking in the background and will manifest soon in terms of the [commercial real estate] losses," he said. "If collectively they all have to tighten credit, the economy will approach a recession faster and that could dent consumer confidence and reduce the demand for credit as well further squeezing margins."

But Acharya downplayed how much additional Fed hikes would add to financial stability risks should the central bank need to double up on its inflation fight.

"If the Fed has to go ahead with another 25bp hike or two, I don't think that's going to be shifting the needle as far as the stability of banks is concerned," he said. "We know that the bulk of the rate hikes we are likely to see have already happened."

QT ON AUTOPILOT

Acharya added that the Fed's program to roll off USD95 billion per month in Treasury and mortgage-backed securities from its USD8.5 trillion balance sheet is "almost on an autopilot at some level." Fed Presidents Raphael Bostic and Austan Goolsbee said Tuesday the bar is a "little high" to make adjustments to QT.

But along the way certain parts of the short end of the yield curve have steepened, with implications for banks and depositors seeking higher yields, said Acharya, who presented a paper at the Kansas City Fed’s Jackson Hole conference last year warning that QT could lead to disruptions in the banking sector.

"I think SVB is an extreme version, but it is a microcosm of what happened to the entire banking system, which is that its balance sheet grew very fast in a short period of time, on the back of uninsured deposits and that is a consequence of quantitative easing," he said.

"My sense is QT has gone fine for what it is but I very much doubt the Fed can do the completion of that exercise given the scale of QE that was undertaken," said Acharya, now a professor at New York University’s Stern School of Business.