The Fed Is Trying To Keep Inflation Under Control Without Putting More Banks At Risk

Despite signals that the Federal Reserve is nearing a quiet period in relation to rate hikes, the decision to raise interest rates by a quarter point on Wednesday represents a delicate balancing act in the absence of an immediate rate hike. There is a concern that the Fed may simply add to the woes that the banking industry currently faces by continuing to fight inflation.

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There is no way for the Fed to know exactly how much more difficult its actions will be going forward due to banking troubles. According to the Federal Open Market Committee's post-meeting statement and the subsequent press conference given by its chairman, Jerome Powell, that was the upshot of this meeting.

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For instance, in the Federal Reserve's policy statement, which was released last week, the Fed announced that "ongoing increases" in the federal funds rate would be appropriate. However, now, given the more opaque language the Fed used, it may be necessary to tighten the policy further.

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Likewise, there was considerable division over the direction in which the economy would go in the Summary of Economic Projections. The median Fed projection of the interest rate in 2023 held steady at 5.1% from the previous meeting, but there were significant differences between the forecasts indicating that some Fed officials do not see more rate increases in the near future, while others are predicting another full percentage point of Fed tightening in 2023.

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He mentioned repeatedly in his press conference that before the central bank could determine whether to proceed with further policy actions, it would have to wait and see how much lending is being reduced as a result of bank problems, thus slowing the economic growth.

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Despite Powell's assurances, the situation remains highly uncertain about how long it will last and how significant each of those aspects would be from an economic standpoint. "So we'll just have to wait and see," Powell told reporters.

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With this shift in rhetoric, the Federal Reserve faces a challenge in handling both the financial turmoil in the economy and rampant inflation without triggering an economic downturn as a result. Despite the central bank's increases in interest rates, a banking crisis will likely encroach on growth-although no one can predict how much or how long it will last. Increasing interest rates will not necessarily slow inflation, it may just slow it by a few percentage points.

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"The Fed's statement, policy action, and dots clearly indicate nervousness," wrote Ian Shepherdson, chief economist of Pantheon Macroeconomics."

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Following Silicon Valley Bank and Signature Bank's failures caused by fleeing deposits, Powell sought to bolster confidence in the U.S. banking system on Wednesday in an effort to ease some of the uncertainty. The issues at the two failed banks aren't widespread throughout the banking system, he stressed. He described the past two weeks' banking turmoil as a "serious challenge at a few banks." The bank's depositors were assured that their savings were safe.

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The Fed itself revised its growth forecasts for each of the next two years in response to the banking problem, as more and more economists are now predicting a recession due to the banking problems.

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There are more questions than answers at the moment for investors and economists, such as: Have interest rates reached their peaks? What happens if inflation spikes again while the banking system remains fragile?

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It will only take time for the Fed of 2023 to figure out where it will go next, as it focuses heavily on telegraphing its next moves.