Fed officials double down on rate hike decision, citing high inflation

Federal Reserve officials on Friday defended their decision to continue the campaign to tighten monetary policy this week despite ongoing tensions in the US banking sector, citing continued concerns about rising inflation.

On Wednesday the central bank higher rates by a quarter point for the second straight time, raising the federal funds rate to a new target range of 4.75% to 5%, even as midsize lenders struggled to weather the fallout from the Silicon Valley Bank collapse.

“There was a lot of arguing … but in the end we decided that there are clear signs that the banking system is sound and resilient,” said Rafael Bostic, president of the Atlanta Fed, in an interview with NPR on Friday. “And against this backdrop inflation is still too high.”

James Bullard, St. Louis Fed President, echoed Bostic’s comments about price pressures, saying inflation remains “too high” and arguing that the central bank was right to continue to squeeze the economy as it has the tools to stabilize the financial system. “Adequate monetary policy could continue to put downward pressure on inflation,” he said.

In Friday’s commentary, Bullard downplayed the impact of the current banking turmoil on the US economy, suggesting it was unlikely to result in a material shock.

“Financial stress can be excruciating, but it also tends to drive down interest rates,” he said in a comment. “Lower rates, in turn, tend to be bullish for the macroeconomics.”

He later told reporters that he estimates the likelihood that the current bout of financial stress will end without further deterioration at 80 percent. This means the Fed is likely to face a hot economy and higher inflation, prompting it to “raise its growth rate somewhat as 2023 progresses,” he said.

The benchmark 10-year Treasury yield fell more than half a percentage point to 3.32 percent after the SVB crash, while the two-year bond yield fell more than a percentage point to 3.63 percent. The two-year yield, in particular, is sensitive to interest rate expectations, and has seen its biggest move since 1987 in recent weeks.

Investors in the futures market on Friday fully appreciated the possibility of an additional quarter-point gain in May. Traders are also betting that the Fed will be forced to cut interest rates this year, which Powell said the Fed does not expect.

At a press conference that followed Wednesday’s rate decision, Fed Chairman Jay Powell recognized officials considered pausing their rate hike campaign in light of the recent banking turmoil, but said the hike was ultimately “supported by a very strong consensus”.

Tom Barkin, president of the Richmond Fed, told CNN on Friday that the case for a rate hike this week is “pretty clear” given that inflation is still “high” and demand “seemed not to have eased.”

But Powell also noted this week that there is still uncertainty about the extent to which a credit crunch could stem from a slowdown in activity at smaller and regional banks, comments that suggested the Fed could be nearing the end of its tightening campaign.

While the Fed’s policy statement noted that “some additional policy hardening may be appropriate,” Powell emphasized to reporters the meaning of the words “some” and “may.”

Bullard told reporters on Friday that he raised his forecast for how much the Fed would raise its benchmark rate this year by a quarter of a percentage point, reflecting stronger growth in the first few months of the year. Now he expects the so-called “terminal” rate of 5.6 percent.

That’s higher than the average estimate made by officials this week, with most forecasting a peak rate of between 5 percent and 5.25 percent. This suggests another quarter-point rate hike and is in line with December’s forecasts.