Fed's Interest-Rate Decision and Tension Between Inflation Fight and Financial Stability

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Fed's Interest-Rate Decision and Tension Between Inflation Fight and Financial Stability

The Federal Reserve’s interest-rate decision, due Wednesday, is under the spotlight as Chair Jerome Powell tries to balance the fight against inflation with a sudden banking crisis. While most economists expect a quarter-point interest-rate hike, some say policymakers should pause to shore up financial stability. Policymakers are set to issue updated rate projections for the first time since December, offering guidance on whether they expect any additional hikes this year. The decision and forecasts will be released at 2 p.m. in Washington with Powell’s press conference 30 minutes later. The Fed’s balance sheet, which had been steadily declining, has rebounded to almost $8.6 trillion with the latest emergency actions to prop up the banking system.

The collapse of three US regional banks and the takeover of Switzerland’s Credit Suisse Group AG has led to a decline in expectations for rate hikes among investors and economists over the last two weeks. Until the bank turmoil erupted, officials were expected to continue their yearlong campaign to raise interest rates and dampen rising prices. Goldman Sachs Group Inc. economists suggest that the FOMC tends to avoid tightening monetary policy in times of financial stress and prefers to wait until the extent of the problem becomes clear, unless it is confident that other policy tools will successfully contain financial stability risks. Torsten Slok, Apollo Global Management chief economist, estimated that the crisis was equivalent to a 1.5 percentage-point increase in the Fed’s target interest rate. The Fed could choose to suspend its projections as it did in March 2020 due to the pandemic.

The FOMC statement is likely to see substantial changes, and the committee could choose to drop its pledge of “ongoing increases” and substitute softer or conditional language that still hints at further tightening. With the FOMC facing tough choices, the judgment could prompt dissent, which has been rare in the past two years. A possible dovish dissent may come from Chicago Fed President Austan Goolsbee, while Neel Kashkari, the Minneapolis Fed president, could argue for a more hawkish move. The FOMC will probably say it’s “closely monitoring developments in financial markets and their implications for the economic outlook”. Powell is likely to be grilled on how the latest turmoil affects financial conditions and the economic outlook and whether he sees a path to reducing inflation without causing a recession.

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