The Federal Reserve and its chairman, Jerome Powell, are facing a legacy-defining moment as their two-day monetary policy meeting concludes on Wednesday.
The mission? Slay the inflation dragon without singeing the banking system.
Among the choices, the Fed could continue its aggressive rate-hike campaign to cool inflation that is running at triple the central bank’s target of 2%. It could take a time-out to assess how that campaign has strained the banking system. Or it could split the difference and raise rates by a quarter point to show its commitment to both the inflation fight and financial system stability. Instead of higher rates for longer, some economists are even penciling in rate cuts late this year if the banking crisis fuels a recession.
For Powell and Co., the stakes are high.
“I don’t think he should be chairman of the Federal Reserve,” Democratic Senator Elizabeth Warren told NBC’s Meet The Press this weekend.
Warren — already a critic of the Fed’s inflation fight — leveled further blistering criticism of the Republican Fed chief. Powell has failed at both monetary policy and bank supervision, she said. Nominated by then-President Donald Trump, Powell was renominated by President Joe Biden in November 2021 for a term ending in 2026.
“In terms of Powell’s legacy, the damage has already been done,” said John Leer, chief economist at Morning Consult. In addition to achieving price stability and financial stability, the Fed’s broader mandate includes supervision of individual financial institutions, Leer says, and “that’s where the failure lies. The SVB fiasco provided the first true opportunity to pressure test the supervisory framework established by Dodd-Frank just over 10 years ago, and the results are abysmal.”
Allianz economist Mohammed El-Erian also gives the Fed low marks in its inflation fight. Inflation was not, it turns out, transitory, as Powell (and, to be fair, many others) forecast early.
“The Fed needs to secure both price stability and financial stability, something that it has failed to so recently,” he told CNN. “Having already dug itself, and the US economy, into a big hole with its prolonged mischaracterization of inflation and flip-flopping policies, it can ill afford another slippage in what is proving to be the biggest policy mistake in the last four decades.”
For any Fed chief, there are more challenges than tools to tackle them. And this Fed chief inherited an unprecedented economy.
“Powell has been stuck between a rock and a hard place from the moment he became Chair,” said Ann Berry, founder of Threadneedle Ventures. He was “handed two administrations without fiscal discipline and two black swan events of a global pandemic and a Twitter-driven bank run.”
“He has read correctly the labor market’s ability to sustain full employment in the face of necessary rate hikes,” she said, “but while I’ve been a Fed apologist until now — because decision making in the face of mixed data is excruciatingly hard — history won’t judge kindly the late start to Fed tightening and the failure to catch SVB’s obviously flawed risk management.”
The crystal ball is murky.
It’s been just two weeks since Powell opened the door to higher and maybe faster interest rate increases, responding to a strong economy and consumer inflation still triple its target.
Since then, three US banks have failed and tens of billions of dollars in customer deposits have flowed out of small and midsized banks into the perceived security of big banks. Ailing Credit Suisse has been taken over by its rival UBS in a central-bank led shotgun wedding. And the US Treasury, the Federal Deposit Insurance Corporation and global central banks have taken measures to protect their own banks and liquidity.
“Taken in isolation, the economy looks very, very good right now. And the Fed would probably be raising rates without what’s going on right now,” said Jay Bryson, chief economist at Wells Fargo. “That said, what’s going on right now is very unsettling that makes the future very uncertain. And we’ve seen a tightening in financial markets. So the Fed may decide to take a pause here just to see how things settle down.”
Economists at Goldman Sachs also expect the Fed to pause, writing in a note to clients this week that “stress in the banking system remains the most immediate concern right now.”
The Fed is set to announce its policy decision Wednesday at 2 p.m. ET, with Chair Powell’s news conference scheduled for 2:30 p.m.