Analysis: Financial or price stability? Bold faces call for pause

March 18 (Reuters) – With the U.S. and European banking crisis wreaking havoc on global markets, some financial industry leaders are calling on the Federal Reserve to pause its monetary tightening for now but be ready to resume interest rate hikes later.

Investors are currently pricing in a 60% probability that the Fed will raise interest rates by 25 basis points on Wednesday, with the rest betting on no change. Some industry leaders said the central bank should prioritize financial stability now.

“Go fast and hard on financial stability; go gradual and slow on price stability,” said Peter Orszag, managing director of financial advisory at investment bank Lazard Ltd ( LAZ.N ). Orszag said the Fed should pause but be ready to raise again gradually as the situation develops.

The central bank declined to comment. Fed officials are in their pre-meeting blackout period, barring them from commenting on monetary policy or the economic outlook.

The Fed has rapidly raised interest rates over the past year in an effort to beat back inflation at a pace not seen since the 1980s. Others have joined in with the European Central Bank raising interest rates by 50 basis points earlier this week.

The rapid rise in interest rates after years of cheap money is rippling through global markets and industry. Two US banks have failed over the past week and others have come under pressure as Swiss lender Credit Suisse struggles to hammer out a bailout deal over the weekend.

The turmoil in the banking sector has sent asset prices plummeting, sending U.S. Treasury yields lower in the past week, with some investors complaining that massive price swings have made it harder to trade. US stocks took a rollercoaster ride, although the S&P 500 managed to close higher for the week despite steep losses in banking stocks.

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WILD CARD

Some market watchers have argued that a sustained pause could raise concerns that consumer prices will rise.

The latest US economic data gives the Fed little reason to believe it has beaten inflation. Consumer prices rose 6% annually in February, nearly three times the central bank’s target, and there have been only beginning signs of a significant easing in hiring and wage growth.

“While the banking problems will certainly garner attention, we believe it is not systemic but more of a liquidity problem that the Fed can contain with its lending facilities,” Bob Schwartz, senior economist at Oxford Economics, wrote in a note.

But he added that the “wild card” will be market reaction.

James Tabacchi, managing director of broker-dealer South Street Securities, said he believed the Fed would eventually have to go above 6%. The current Fed funds rate is 4.5% to 4.75%.

“I’m an inflation hawk. But what will it hurt to wait a month and say, ‘We want to see the market stabilize?'” Tabacchi said. “I think the Fed should pause.”

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DISINFLATIONARY TRENDS

Orszag, who served as director of the US Office of Management and Budget in the Obama administration, said that as long as long-term inflation expectations were not unfettered, as they were now, the Fed had time. Raising interest rates too quickly could break things, as the current banking crisis showed.

A number of factors pointed to the lingering effects of the pandemic on inflation, such as supply chain disruptions and demand for travel and entertainment.

In a new paper, Orszag and co-author Robin Brooks, chief economist at the Institute of International Finance, estimated that lagged effects associated with delivery times could explain between 30% and 70% of elevated core PCE inflation in the fourth quarter of 2022. That would resolve over time and be a disinflationary force this year, they said.

Torsten Slok, chief economist at Apollo Global Management, wrote in a memo on Saturday that the recent tumult in the banking sector is already tightening financial conditions. The events of the past week equate to a 1.5% increase in the Fed funds rate, Slok wrote.

“In other words, over the past week monetary conditions have tightened to the point where the risk of a sharper slowdown in the economy has increased,” he said.

BlackRock Inc ( BLK.N ) strategists argued that the past week’s swings showed markets had woken up to the damage caused by the rapid rise and pricing in a recession.

“The trade-off for central banks – between fighting inflation and protecting both economic activity and financial stability – is now clear and immediate,” they wrote in a report earlier this week.

Reporting by Paritosh Bansal and Ira Iosebashvili; additional reporting by Dan Burns; Editing by Nick Zieminski

Our standards: Thomson Reuters Trust Principles.

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